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Chapter 1:

1. Define economics and understand the importance of the fact that there are
unlimited wants but only limited resources available to satisfy them.
Economics the study of how people allocate their limited resources in an
attempt to satisfy their unlimited wants. As such, economics is the study of how
people make choices.
2. Distinguish the difference between microeconomics and macroeconomics.
microeconomics the part of the economic analysis that studies decision
making undertaken by individuals and by firms.
macroeconomics the part of the economic analysis that studies the behavior
of the economy as a whole.
3. List and discuss the three basic economic questions every society must answer
and the two antithetical answers to these questions of which existing societies
are a mixture.
1. What and how much will be produced? Some mechanism must exist for
determining which items will make it to production and which items will
remain pipe dreams.
2. How will items be produced? An item can be produced with the aim of
maximizing the number of people employed, or to minimize the total
expenses that members of society incur. A decision must be made about
the mix of resources used in production, the way in which they are
organized, and how they are brought together at a particular location.
3. For whom will items be produced? Once an item is produced, who
should be able to obtain it? Determining a mechanism for distributing
produced items is a crucial issue for any society.
centralized command & control a centralized authority decodes what
items to produce (and how many), how the scarce resources will be
organized in the items production, and identifies who will be able to obtain
the items.

price system individuals own all the scarce resources, determine the
quantity of good produced and how to go about producing them, and
determine how to allocate their income to obtain goods.
4. Understand the importance of rationality in economic analysis.
We assume that individuals do not intentionally make decisions that would
leave themselves worse off. Economics makes predictions based on the best
possible outcome.
5. Understand what economics means be self-interest and the important role it
plays in economic models.
Goals are assumed to include those not just associated with monetary gains. By
extension this can also be thought of in terms of individuals in pursuit of what
makes them better off also achieve the betterment of others around them.

6. Explain the importance of models and understand the role of assumptions in


economic models.
Models are simplified representatives of the real world that we use to help us
understand, explain, and predict economic phenomena in the real world. Social
scientists usually test their models and theories by examining what has already
happened in the real world. An economic model cannot be faulted as
unrealistic simply because it does not represent every detail of the real world.

7. Understand the concept of behavioral economics and bounded rationality.


Behavioral economics examines consumer behavior in the face of
psychological limitations and complications that may interfere with rational
decision-making. Bounded rationality suggest that traditional economic models
assume that people exhibit three unrealistic characteristics:
unbounded selfishness people are only interested in their own satisfaction
unbounded willpower their choices are always consistent with their long
term goals
unbounded rationality they are able to consider every relevant choice

Bounded rationality basically assumes that people cannot examine and think
through every possible choice they confront.
8. Distinguish the difference between positive and normative economics.
positive economics analysis that is strictly limited to making either purely
descriptive statements or scientific predictions. A state of what is.
normative economics analysis involving value judgments about economic
policies; relates to whether outcomes are good or bad. A state of what ought to
be.
9. Know how to construct a graph.
Production possibilities curve (PPC) - a curve representing all possible
combinations of maximum outputs that could be produced, assuming a fixed
amount of productive resources of a given quality
10.Distinguish the difference between direct and inverse relationships.
direct relationship an increase in one variable will result in an increase in the
related variable
inverse relationship an increase in one variable will result in a decrease in
the related variable

Chapter 2:

11. Define and understand of the concept of scarcity.


Scarcity means that we do not ever have enough of anything, including time, to
satisfy our every desire. It exists because human wants always exceed what can
be produced with the limited resources and time that nature makes available.
12.Explain and distinguish between the factors of production.
Production is any activity that results in the conversion of resources into
products that can be used in consumption. The resources used in production
are called factors of production; the total quantity of all resources that an
economy has at any one time determines what that economy can produce.
land natural resources; all the nonhuman gifts of nature
labor human resources; includes productive contributions made by
individuals who work
physical capital consists of the factories and equipment used in production;
also includes improvements to natural resources
human capital the economic characterization of the education and training
of workers
entrepreneurship (actually a subdivision of labor) the component of human
resources that performs the functions of organizing, managing, and assembling
the other factors of production to create and operate business ventures

13.Understand the difference between wants and needs and the concept of
economic goods.
The term needs is objectively undefinable; there is no way to know if the person
is stating a vague wish, a want, or a life-saving requirement. Humans have
unlimited wants and no way to satisfy them all, whether they are materialistic
or ephemeral wants.

14.Explain the idea of opportunity cost.


Opportunity cost is the highest-valued, next-best alternative that must be
sacrificed to obtain something or to satisfy a want.
15.Draw a graph a production possibilities curve.

16.Discuss the idea of efficiency and inefficiency


Efficiency is the case in which a given level of inputs is used to produce the
maximum output possible. Alternatively, it is the situation in which a given
output is produced at minimum cost. Inefficiency concerns any point below the
production possibilities curve, at which the use of resources is not generating
the maximum possible output.
17.Understand the idea of increasing additional cost.
The Law of increasing additional cost is the fact that the opportunity cost of
additional units of a good generally increases as people attempt to produce
more of that good. This accounts for the bowed-out shape of the production
possibilities curve.
18.Discuss economic growth and the trade-off between consumption and capital
goods.
Economic growth occurs for many reasons, including increases in the number
of workers and productive investment in equipment. Scarcity will still exist,
however, no matter how much economic growth takes place. An opportunity
cost is involved between consumption and capital goods; when we dont use
resources to produce consumer goods today, we invest in capital goods that
will produce more consumer goods later.

19.Explain absolute and comparative advantage.


absolute advantage the ability to produce more units of a good or service
using a given quantity of labor or resource inputs
comparative advantage the ability to perform an activity at a lower cost
Only comparative advantage not absolute advantage - matters in
determining how you will allocate your time. It determines your choices
because it involves the highest-valued alternative in a decision about time
allocation.
20.Discuss specialization, division of labor and trade between nations
specialization when people make choices, they attempt to maximize benefits
net of opportunity cost. In doing so, individuals choose their comparative
advantage and end up specializing.
division of labor the different uses of labor are organized in such a way as to
increase the amount of output possible from the fixed resources available.
trade between nations when nations specialize in an area of comparative
advantage and then trade with the rest of the world, the average standard of
living in the world rises.

Chapter 3:

21.Explain the law of demand.


The observation that there is a negative, or inverse, relationship between the
price of any good or service and the quantity demanded, holding other factors
constant.
22.Discuss the difference between money prices and relative prices.
money price the price expressed in todays dollars; also called the absolute
or nominal price

relative price the money price of one commodity divided by the money price
of another commodity; the number of units of one commodity that must be
sacrificed to purchase one unit of another commodity
23.List and explain the other determinants of demand besides the price of the good
or service.
ceteris paribus conditions (determinants of the relationship between price
and quantity that are unchanged along a curve; changes in these factors
cause the curve to shift) consumers income [an increase in income will lead
to an increase in demand], tastes and preferences [changes can shift the
demand curve], the prices of related goods [two goods are substitutes when a
change in the price of one causes a shift in demand for the other in the same
direction as the price change], expectations regarding future prices and future
incomes [customer expectation regarding future prices and incomes will
prompt them to buy more or less of a particular good without a change in its
current money price], and market size (number of potential buyers) [an
increase in the number of potential buyers at any given price shifts the
market demand curve outward]
24.Understand the difference between changes in the quantity demanded and
changes in demand.
quantity demanded a change in a goods own price leads to a change in
quantity demanded for any given demand curve, other things held constant.
This is a movement along the curve.
changes in demand a change in any of the ceteris paribus conditions for
demand leads to a change in demand. This causes a shift of the curve itself.
(The following learning objective is listed twice to indicate that there will be
two questions on this topic.)
25.Understand the difference between changes in the quantity demanded and
changes in demand.
quantity demanded a single point on the curve
demand the entire curve
26.Explain the law of supply.

The law of supply is the observation that the higher the price of a good, the
more of that good sellers will make available over a specified time period,
other things being equal.
27.Understand the determinants of supply.
ceteris paribus conditions of supply [assumed to be constant] prices of
resources used to produce the product, technology and productivity, taxes and
subsidies, producers price expectations, and the number of firms in the
industry
28.Distinguish between changes in the quantity supplied and changes in supply.
changes in quantity supplied a change in price leads to a change in the
quantity supplied, other things being constant. This is a movement along the
curve. A single point on the curve.
changes in supply a change in any ceteris paribus condition for supply leads
to a change in supply. This causes a shift of the curve itself. The entire curve.
(The following learning objective is listed twice to indicate that there will be
two questions on this topic.)
29.Understand the process of determining market equilibrium quantity and
equilibrium price.
equilibrium price clears the market of all excess quantities demanded or
supplied. Consumers are able to get all they want at that price, and suppliers
are able to sell all they want at that price.
market equilibrium quantity the point at which the market quantity supplied
is equal to the market quantity demanded
30.Understand the process of determining market equilibrium quantity and
equilibrium price.
The equilibrium price of a good and the equilibrium quantity of a good that is
produced and sold are determined by the intersection of the demand and supply
curves; at the intersection, there is neither an excess quantity of the good
supplied nor an excess quantity of the good demanded.

Chapter 4
31.Discuss the essential features of the price system.
the price system is an economic system in which relative prices are constantly
changing to reflect changes in supply and demand for different commodities;
the prices of those commodities are signals to everyone within the system as to
what is relatively scarce and what is relatively abundant.
(The following learning objective is listed twice to indicate that there will be
two questions on this topic.)
32.Evaluate the effects of changes in demand and supply on the market
equilibrium price and quantity.
When both demand and supply increase, the equilibrium quantity
unambiguously rises, because the increase in demand and the increase in
supply both tend to generate a rise in quantity. Both increases generate an
increase in quantity demanded and supplied.
33.Evaluate the effects of changes in demand and supply on the market
equilibrium price and quantity.
When demand decreases and supply increases at the same time, the equilibrium
price will fall, because both the decrease in demand and the increase in supply
tend to push down the equilibrium price. The decrease in demand tends to
reduce the equilibrium quantity, whereas the increase the increase in supply
tends to increase the equilibrium quantity.
34.Understand the various methods of rationing.
rationing by waiting first come>first served, rationing by queue; all waiting
in line are paying a higher total outlay than the money price paid for the good.
Personal time has an opportunity cost.

rationing by random assignment or coupons random assignment is used to


fill up/get rid of excess/extra goods, and coupons force the customer to pay a
specified price and give up a coupon.

35.Explain the effects of price ceilings.


Price ceilings are legal maximum prices that may be charged for a particular
good or service. Normally, whenever quantity demanded exceeds quantity
supplied (a shortage) there is a tendency for the price to rise to its equilibrium
level; with a price ceiling, this tendency cannot be fully realized because
everyone is forbidden to trade at the equilibrium price.
36.Discuss the economics of rent control.
Rent control has the sole objective of keeping rents below levels that would be
observed in a freely competitive market. Rents are the most important longterm determinant of profitability, and rent controls artificially depress them.
Rent controls also discourage the construction of new rental units.
37.Explain the effects of price floors.
Price floors are also called quantity restrictions in that they manage the
quantity produced and thus the quantity supplied.
38.Understand agricultural price supports.
Agricultural price supports are chosen by the government, who then ensures
that the price of the product never falls below the support level (usually around
the market clearing price); however, if the government purposefully sets this
price point above the market clearing price, then a surplus of the agricultural
product is generated.
39.Understand the economics of the minimum wage.
The minimum wage is a wage floor, legislated by government, that sets the
lowest hourly rate that firms may legally pay workers; the minimum wage set
can affect the quantity of labour demanded.

40.Discuss the various types of government-imposed quantity restrictions on


markets.
outright ban on the ownership or trading of a good exactly what it says.
requiring a license to sell a particular good or service lowers the number of
qualified suppliers and thus lowering the quantity supplied.
import quota a supply restriction that prohibits the importation of more than
a specified quantity of a particular good in a one-year period.
Chapter 5 & 6:

CHAPTER 5
1. Explain how market failures such as externalities might justify the economic
functions of government.
Market failures can justify a governments ability to control prices and
production that bear weight on the opportunity cost paid by society as a whole.
2. Distinguish between private goods and public goods and explain the nature of
the free-rider problem.
private goods goods that can be consumed by only one individual at a time.
Private goods are subject to the principle of rival consumption.
public goods goods for which the principle of rival consumption does not
apply and for which exclusion of nonpaying consumers is too costly to be
feasible; they can be jointly consumed by many individuals simultaneously at
no additional cost and with no reduction in quality or quantity.
free-riders a situation in which some individuals take advantage of the fact
that others will assume the burden of paying for public goods such as national
defense.

3. Describe political functions of government that entail its involvement in the


economy.
Political functions such as the ability to subsidize a good or to inhibit the trade
of a good allow the government to control parts of the economy in the interest
of protecting consumers and suppliers alike. Its ability to redistribute income
ensures that all levels of society have access to basic necessities.
4. Analyze how Medicare affects the incentives to consume medical services.
Demand for and consumption of Medicare subsidies are offset by the fact that
the larger number of services can only be extracted from suppliers at a higher
price; thus, the incentives for Medicare have increased the total amount spent
on its services and goods from total incomes.
5. Explain why increases in government spending on public education have not
been associated with improvements in measures of student performance.
A higher per-student subsidy creates a difference between the relatively high
per-unit costs of providing the number of educational services that parents and
students are willing to purchase and lower valuations of those services. As a
consequence, some schools provide services that contribute relatively little to
student learning.
6. Discuss the elements of the theory of public choice.
The theory of public choice examines the ways in which individuals and
parties collectively reach decisions in the public sector of the economy, namely
through one of two ways:
majority rule a collective decision-making system in which group decisions
are made on the basis of more than 50% of the vote.
proportional rule a decision-making system in which actions are based on
the proportion of the votes cast and are in proportion to them.

7. Distinguish between average tax rates and marginal tax rates.


average tax rates the total tax payment divided by total income; it is the
proportion of total income paid in taxes.
marginal tax rates the change in the tax payment divided by the change in
income, or the percentage of additional dollars that must be paid in taxes; the
marginal tax rate is applied to the highest bracket of taxable income reached.
8. Explain the structure of the U.S. income tax system.
federal revenues individual income taxes, social insurance taxes and
contributions, corporate income taxes, excise taxes, other taxes
state revenues revenue from the federal government, sales & excise & gross
receipt taxes, property taxes, personal & corporate income taxes, license &
permit (etc.) taxes, other taxes
9. Understand the key factors influencing the relationship between tax rates and
the tax revenues governments collect.
static tax analysis economic evaluation of the effects of tax rate changes
under the assumption that there is no effect on the tax base.
dynamic tax analysis economic evaluation of tax rate changes that
recognizes that the tax base declines with ever-higher tax rates, so that tax
revenues may eventually decline if the tax rate is raised sufficiently.
10.Explain how the taxes governments levy on purchases of goods and services
affect market prices and equilibrium quantities.
In order to continue supplying a good that the government has levied taxes on
at the same given quantity, suppliers must give consumers a price increased
with the tax cost, thus moving the market supply curve upward by the tax
amount. This decrease in market supply causes a reduction in the equilibrium
quantity of the good that is produced and purchased, and causes a rise in the
market clearing price so that consumers will pay part of the tax.

Chapter 7:

The Macroeconomy: Unemployment, Inflation & Deflation, and the


Business Cycle Unemployment:
11. Answer the following:
a) name the government bureau responsible for unemployment data and
the employment categories it uses in doing so.
employed & unemployed combined to make up the labor force
not in the civilian labor force includes homemakers, full-time students,
military personnel, persons in institutions, and retired persons
b) describe the history of the unemployment rate since 1890.
The unemployment rate spikes repeatedly, with major increases in
unemployment rates during major events (i.e. WWI, WWII)
12.Answer the following:
a) list the four categories an unemployed individual might fall into
according to the Bureau of Labor Statistics.
job loser employment was involuntarily terminated or was laid off(40-60
percent of the unemployed)
reentrant worked a full-time job before but has been out of the labor force
(20-30 percent of the unemployed)
job leaver who voluntarily ended employment (less than 10 to around 15
percent of the unemployed)
new entrant never worked a full-time job for two weeks or longer (10-15
percent of the unemployed)

b) define what is meant by a discouraged worker.


individuals who have stopped looking for a job because they are convinced that
they will not find a suitable one.
c) explain why knowing the average duration and costs of unemployment
is important.
The longer individuals stay in unemployment, the greater number of them there
are at any given time.
13.Be able to calculate the unemployment rate or the labor force participation
rate from given data.
The Major Types of Unemployment and the Concept of Full Employment
(also know as the Natural Rate of Unemployment):
14.List and describe the three major types of unemployment according to
economists.
frictional unemployment due to the fact that workers must search for
appropriate job offers; this activity takes time, and so they remain temporarily
unemployed.
structural unemployment of workers over lengthy intervals resulting from
skill mismatches with positive requirements of employers and from fewer jobs
being offered by employers constrained by governmental business regulation
and labor market policies.
cyclical unemployment resulting from business recessions that occur when
aggregate (total) demand is insufficient to create full employment.

15.Define what is meant by full employment and by the natural rate of


unemployment and how they relate to the four types of unemployment is
learning objective 4.
full employment an arbitrary level of unemployment that corresponds to
normal friction in the labor market.
natural rate of unemployment - the rate of unemployment that is estimated to
prevail in long-run macroeconomic equilibrium, when all workers and
employers have fully adjusted to any changes in the economy.
Some economists have proposed that the increase in the natural rate of
unemployment is due to a rise in structural unemployment; others say that
government policies are to blame for a higher natural unemployment rate.
Price stability and price indices:
16.To do the following:
a) differentiate inflation from deflation and explain how each affects the
purchasing power of money.
inflation a sustained increase in the average of all prices of goods and
services in an economy.
deflation a sustained decrease in the average of all prices of goods and
services in an economy.

b) list and describe the various price indices published by the U.S.
government.
Consumer Price Index (CPI) a statistical measure of a weighted average of
prices of a specified set of goods and services purchased by typical consumers
in urban areas. The CPI attempts to measure changes only in the level of
prices of goods and services purchased by consumers.
Producer Price Index (PPI) a statistical measure of a weighted average of
prices of goods and services that firms produce and sell. The PPI attempts to
show what has happened to the average price of goods and services produced
and sold by a typical firm (there are also wholesale price indexes that track
the price level for commodities that firms purchase from other firms).
GDP deflator a price index measuring the change in prices of all new goods
and services produced in the economy. The GDP deflator is the most general
indicator of inflation because it measures changes in the level of prices of all
new goods and services produced in the economy.
Personal Consumption Expenditure (PCE) Index a statistical measure of
average prices that uses annually update weights based on surveys of
consumer spending. The PCE Index measures average prices using weights
from surveys of consumer spending.
17.To be able to measure inflation with a price index, with a good
understanding of how the different price indexes work.
Inflation's impact on the economy:
18.To do the following:
a) explain the difference between anticipated and unanticipated inflation.
anticipated inflation the inflation rate that we believe will occur; when it
does occur, we are in a situation of fully anticipated inflation.
unanticipated inflation inflation at a rate that comes as a surprise, either
higher or lower than the rate anticipated.

19.
b) explain the relation between the nominal interest rate and the real
interest rate.
nominal interest rate the market rate of interest observed in the contracts
expressed in todays dollars.
real interest rate the nominal rate of interest minus the anticipated rate of
inflation.
20.Explain how inflation affects people and what economists think is the main
cost of inflation.
Some people are negatively affected by inflation attempt to halt the loss of
money by investing in nominal plans; others benefit (creditors: 0, debtors: 1).
Economists believe that the main of cost of inflation in the opportunity cost of
resources used to protect against distortions that inflation introduces as firms
attempt to plan for the long run.
Business Fluctuations:
21.Explain what is meant by business fluctuations, list the phases of the
business cycle, and give an overview of the history of business fluctuations
in the United States since 1880.
business fluctuation the ups and downs in business activity throughout the
economy.
expansion a business fluctuation in which the pace of national economic
activity is speeding up.
contraction a business fluctuation during which the pace of national
economic activity is slowing down.
recession a period of time during which the rate of growth of business actvity
is consistently less than its long-term trend or is negative.
depression an extremely severe recession.

Chapter 8:
The Circular Flow of Income and Output:
21.To do the following:
a) define what is meant by National Income Accounting.
national income accounting a measurement system used to estimate national
income and its components. One approach to measuring an economys
aggregate performance.
b) reproduce the circular flow of income and output correctly labeling all
actors, markets, and flows.
c) explain why profits are a cost of production.
Profits are a cost of production because entrenpreneurs must be rewarded for
providing their services or else they wont provide them.
22.To do the following:
a) discuss what is exchanged in the product markets and in the factor
markets.
product markets consumer goods and services flow to household demanders,
while money flows in the opposite direction to business suppliers.
factor markets households sell resources such as labor land, capital, and
entrepreneurial ability in return for receipts or income from business
expenditures.
b) explain why dollar value of all output must equal total income.
Spending by one group is income to another. It is also a mater of simple
accounting and the economic definition of profit as a cost of production.

GDP defined: the total market value of all final goods and services produced
during a year by factors of production located within a nations borders.
23.To do the following:
a) give the definition of GDP
the total market value of all final goods and services produced during a year
by factors of production located within a nations borders.
b) explain why it is a flow concept and not a stock concept
Its a flow of production; it is necessary to specify a time period for all flows.
Income received is a flow.
c) identify two main methods of measuring it.
1. expenditure approach
2. income approach
d) explain why intermediate goods are not included in the definition
using the idea of value added.
To include intermediate goods in the definition is to include it twice, and
value added states that each good has exactly one value; thus, there is no
rationale in including intermediate goods twice.
24.List all other transactions that are not included in GDP and explain why
they are not included.
the buying & selling of securities no producing activity was performed; it is
merely a transfer of ownership
government transfere payments payments for which no productive services
are concurrently provided in exchange
private transfer payments merely a transfer of funds from one individual to
another
Limitations of GDP:

25.Explain some of the limitations of GDP and why GDP is often not an accurate
measure of national well-being.
GDP excludes nonmarket production GDP only includes the value of goods
and services traded in markets; this can cause some problems in comparing the
GDPs of a highly industrialized country and a highly agrarian nation. It can
also cause problems if nations have differing definitions of legal versus illegal
activites.
GDP is not a direct measure of human well-being no measured figure of
total national annual income can take account of changes in the degree of
labor market discrimination, declines or improvements in personal safety, or
the quantity or quality of leisure time. Measured GDP also says little about
environmental quality of life.

Calculating GDP by the expenditure approach:


26.To do the following:
a) list the components that comprise the expenditure approach to
measuring GDP.
b) explain what is contained in each component.
durable consumer goods arbitrarily defined as items that last more than
three years (automobiles, furniture, household appliances)
nondurable consumer goods everything else (food, gasoline)
services intangible commodities (medical care, education)

27.Explain how depreciation (capital consumption allowance) connects GDP


to NDP and gross private domestic investment to net investment.

Depreciation is defined as the reduction in the value of capital goods over a


one-year period due to physical wear and tear and also to obsolescence; net
domestic product (NDP) is calculated to be GDP minus depreciation.
Calculating GDP by the income approach:
28.To do the following:
a) list the components that comprise the income approach to measuring
GDP.
b) explain what is contained in each component.
wages includes salaries and other forms of labor income, such as income in
kind and incentive payments; because GDI measures all income, there is no
deduction from wages for Social Security taxes (whether paid by empoyees or
employers)
interest expressed in net rather than in gross terms; the interest component of
total income is only net interest received by households plus net interest paid to
us by foreign residents. Net interest received by households is the difference
between the interest they receive and the interest they pay.
rent all income earned by individuals for the use of their real (nonmonetary)
assets such as farms, houses, and stores; also included are royalties received
from copyrights, patents, and assets such as oil wells.
profits includes total gross corporate profits plus proprietors income; this
income is income earned from the operation of unincorporated businesses,
which include so proprietorship partnerships, and producers cooperatives. It
is unincorporated business profit.

c) be able to list the other three measures of national income besides GDP
and NDP, and
d) show how all five are related to one another.

National Income (NI) the total of all factor payments to resource owners; it
can be obtained from NDP by subtracting indirect business taxes and transfers
and adding net U.S. income earned abroad and other business income
adjustments.
Personal Income (PI) the amount of income that households actually receive
before they pay personal income taxes.
Disposable Personal Income (DPI) personal income after personal income
taxes have been paid.
Nominal GDP vs. Real GDP:
To do the following:
a) distinguish between nominal GDP and real GDP.
b) explain why the distinction matters.
nominal values the values of variables such as GDP and investment
expressed in current dollars, also called money values; measurement in terms
of the actual market prices at which goods and services are sold.
real values measurements of economic values after adjustments have been
made for changes in the average of prices between years.
c) be able to correct nominal GDP for changes in the price index (the GDP
deflator).

Comparing GDP per capita of different countries:


29.To do the following:
a) discuss why using purchasing power parity when converting one

countrys GDP into the currency value of another county is preferred to


using the current exchange rate.
Purchasing power parity is defined as the adjustment in exchange rate
conversion that takes into account differences in the true cost of living across
countries. This allows for GDP to include goods and services that are not
otherwise included (they are not sold in the world market).
b) be able to describe the per capita GDP of the U.S. as it compares to
other countries using both approaches
GDP per capita of the U.S. is in fact increasing at a higher rate and from a
higher starting point than other countries as it does trade (import/export) more
goods than do other nations.

Chapter 9:
Economic Growth:
31.Explain what is meant by economic growth.

Economic growth is defined as increases in per capita real GDP measured by


its rate of change per year. Economic growth occurs when there are increases
in per capita real GDP, measured by the rate of change in per capita real GDP
per year.
32.To do the following:
a) discuss historical record of economic growth in the U.S.
From the start of the 1900s the U.S. has experienced a steady, positively sloped
economic growth, only occasionally dipping through various economic shocks
but also profiting immensely from certain wars.
b) describe the ranking of the twelve countries growth rates listed in Table
9-1 from 1970 to 2011.
The countries with the lowest annual rate of growth of real GDP per capita are
developed, highly industrialized nations; on the other end, the countries with
the highest average annual rate of growth of real GDP per capita are
developing third-world countries that have massive populations that power
their production.
c) discuss criticisms of economic growth
The more the economy grows, the more needs are created so that we feel
worse off as we become richer. Our expectations are rising faster than reality,
so we presumably always suffer from a sense of disappointment. Also,
economists measurement of economic growth does not take into account the
spiritual and cultural aspects of the good life.

Small differences in growth rates add up over time:


33.Explain why small differences in growth rates between countries can add up to
big differences over the long term and be able to use Table 9-3.

The small differences in growth rates between countries do not matter very
much in the short run; however, those differences compound over longer
periods of time.
Traditional sources of economic growth:
34.Explain how increased productivity contributes unambiguously to greater
annual increases in a nation's per capita GDP.
labor productivity total real domestic output (real GDP) divided by the
number of workers (output per worker)
Increased productivity is based on an individuals ability to produce the same
output with fewer inputs. By definition, labor productivity increases whenever
average output produced per worker (or per hour worked) during a specified
time period increases.
35.Explain why saving is such an important determinant of economic growth.
(Figure 9-3)
To have more consumption in the future, you have to consume less today and
save the difference between your income and your consumption. Savings are
important for economic growth because without saving, we cannot have
investment; if there is no investment in our capital stock, there will be much
less economic growth.
36.Describe the importance of more labor, increased capital, and improved
human capital.
more labor more labor implies greater production rate, which then improves
the economy as the nation has more goods to contribute to world trade
increased capital allows for nations to invest more in research and
development of improved technology and goods for trade
improved human capital nations have a greater pool of intelligence to draw
from concerning the design, production, and trade of goods

New Growth Theory:


37.Explain how new growth theory differs from traditional growth theory.

new growth theory a theory of economic growth that examines the factors
that determine why technology, research, innovation, and the like are
undertaken and how they interact.
The new theory argues that technology cannot simply be viewed as an outside
factor without explanation; technology must be understood in terms of what
drives it.
38.Explain the connection of innovation, patents, knowledge, new ideas,
improved human capital, an open economy, and R&D to advancements in
technology.
Innovation and new ideas stem from base knowledge granted from improved
human capital; with an open economy, individuals and partners can use
patents to protect their innovative ideas from being copied so that they alone
reap the profits. These profits are what allow these individuals and partners to
invest in further research & development to improve upon their own
innovations such innovations are what contribute to the continual advance of
technology.
Population and economic development:
39.To do the following:
a) discuss the relationship between immigration and economic growth.
The population growth can result in a larger labor force and increases in
human capital, both of which contribute to economic growth. On the other
hand, population growth can be seen as a drain on the economy because for
any given amount of GDP, more population means lower per capita GDP.

b) explain Thomas Malthus' theory of the relationship between population


growth and standards of living.
Increases in population growth also leads to increased consumption of existing
food supplies, which will decrease in equal portions being distributed, which in
turn results in lower standards of living for everyone.

c) explain what the world has discovered about the relationship between
economic growth and population growth.
Demand and production have increased to match the needs of the larger
population size. As families become richer, the average family size declines; the
more economic development occurs, the slower the population growth rate
becomes. This can be visualized as a bell-shaped curve graph.
40.List and explain the four factors that seem to be highly correlated to the
pace of economic development.
establishing a system of property rights the more secure private property
rights are, the more private capital accumulation and economic growth there
will be
developing an educated population a more educated workforce aids
economic development because it allows individuals to build on the ideas of
others; as stated in the negative, economic development is difficult to sustain if
a nation allows a sizable portion of its population to remain uneducated.
letting creative destruction run its course allowing new business to
ultimately create new jobs and economic growth after first destroying old jobs,
companies, and industries; although necessary for economic advancement,
many governments in developing nations have had a history of supporting
current companies and industries by discourage new technologies and
companies from entering the marketplace.
limiting protectionism trade encourages people and businesses to discover
ways to specialize so that they can become more productive and earn higher
incomes; thus, having fewer trade barriers promotes faster economic
development.

Chapter 10:

Long Run Aggregate Supply and Economic Growth:

31.To do the following: a) draw a sketch of a long run aggregate supply curve
(LRAS), and b) discuss the relationship between the production
possibilities curve and the LRAS curve.

32.Explain why the long run aggregate supply curve has the shape that it has
and its meaning to economic analysis.
The LRAS is a vertical line because it represents the real output of goods and
services after a full adjustment has occurred; it can also be viewed as
representing the real GDP of the economy under conditions of full employment.
The long run is a sufficiently long period that all factors of production and
prices, including wages and other input prices, can change.
33.Illustrate economic growth with a PPC and with a LRAS curve and list the
sources of that growth.

The Aggregate Demand Curve:


34.Draw a sketch of the aggregate demand (AD) curve and discuss its
meaning to economic analysis.
aggregate demand (AD) the total of all planned expenditures in the entire
economy; determines the total amount that individuals, firms, governments,
and foreign residents want to spend, as well as the equilibrium price level and
the rate of inflation (or deflation).
aggregate demand curve a curve showing planned purchase rates for all
final goods and services in the economy at various price levels, ceteris paribus;
gives the total amount of real domestic final goods and services that will be
purchased at each price level.

35.Explain the impact of price level changes on the quantity demanded of all
output with the use of the real balance effect, the interest rate effect, and
the open economy effect.

real-balance effect the change in expenditures resulting from a change in the


real value of money balances when the price level changes, ceteris paribus;
also called the wealth effect.
interest rate effect one of the reasons that the aggregate demand curve
slopes downward: higher price levels increase the interest rate, which in turn
causes businesses and consumers to reduce desired spending due to the higher
cost of borrowing.
open economy effect one of the reasons that the aggregate demand curve
slopes downward: higher price levels result in foreign residents desiring to buy
fewer U.S.-made goods, while U.S. residents now desire more foreign-made
goods, thereby reducing net exports; this is equivalent to a reduction in the
amount of real goods and services purchased in the United States.
36.Discuss what factors can cause a shift of the AD curve to the right (an
increase in AD) and what factors can cause a shift of the AD curve to the
left (a decrease in AD).
AD shifts to the right any non-price-level change that increases aggregate
spending (on domestic goods)
[An increase in the amount of money in circulation
Increased security about jobs and future income
Improvements in economic conditions in other countries
A reduction in real interest rates (nominal interest rates corrected for inflation)
not due to price level changes
Tax decreases
A drop in the foreign exchange value of the dollar]

AD shifts to the left any non-price-level change that decreases aggregate


spending (on domestic goods)
[A decrease in the amount of money in circulation
Decreased security about jobs and future income

Decline in economic conditions in other countries


A rise in real interest rates (nominal interest rates corrected for inflation) not
due to price level changes
Tax increases
A rise in the foreign exchange value of the dollar]
Long Run Macroeconomic Equilibrium:
37.Explain how to use the model of the LRAS curve with the AD curve to
determine macroeconomic equilibrium and to further explain what happens if
the price level is not at the equilibrium level.
The equilibrium price level occurs at the point where the aggregate demand
curve (AD) crosses the long-run aggregate supply curve (LRAS); at this point,
the total of all planned real expenditures for the entire economy is equal to
actual real GDP produced by firms after all adjustments have taken place.
Thus, the equilibrium point is the economys long-run equilibrium.
If the price level is not at the equilibrium level, the total planned real
expenditures by individuals, businesses, and the government would exceed the
actual real GDP. Inventories of unsold goods would begin to be depleted, the
price level would rise, and higher prices would encourage firms to expand
production and replenish inventories of goods available for sale.

LRAS/AD Model, Economic Growth, and the Price Level:


38.Explain how economic growth can lead to deflation using the LRAS/AD
model.

secular deflation a persistent decline in prices resulting from economic


growth in the presence of stable aggregate demand.
If all the factors that affect total planned real expenditures are unchanged, so
that the aggregate demand curve does not noticeably move during the 10-year
period of real GDP growth, the growing economy would experience deflation.
LRAS/AD Model and Inflation:
39.Use the LRAS/AD model to illustrate and explain supply side inflation.
A decline in the long-run aggregate supply shows that one possible reason for
persistent inflation would be continual reductions in economy wide production.
40.Use the LRAS/AD model to illustrate and explain demand side inflation.
If aggregate demand increases for a given level of long-run aggregate supply,
the price level must increase.

Chapter 11:
The Classical Model of Macroeconomic Activity:

11. Explain who the Classical Economists were, state what Says Law is and
explain what it means.
Classical Economists = Adam Smith, J.B. Say, David Ricardo, John Stuart
Mill, Thomas Malthus, A.C. Pigou
Says Law = Supply creates its own demand. Hence, it follows that desired
expenditures will equal actual expenditures.
Says Law means that producing goods and services generate the means and
the willingness to purchase other goods and services. People produce more
goods than they want to use only if they seek to trade them for other goods.
Someone offers to supply something only because he or she has a demand for
something else.
12.List the four assumptions of the Classical Model and explain the
implications of these assumptions.
1. Pure competition exists No single buyer or seller of a
commodity or an input can affect its price
2. Wages and prices are flexible Prices, wages and interest rates
are free to move to whatever supply and demand dictates.
Although no individual buyer can set a price, a community of
buyers or sellers can cause prices to rise or to fall to an
equilibrium level
3. People are motivated by self-interest businesses want to
maximize their profit, and households wants to maximize their
economic well-being
4. People cannot be fooled by money illusion buyers and sellers
react to changes in relative prices. For example, workers will not
be fooled into thinking that doubling their wages makes them
better off if the price level has also doubled during the same time
period
The classical economics conclude that the role of government in the
economy should be minimal based on the 4 assumptions. Any
problems in the macro-economy will be temporary. The market will
correct itself.

13.Explain and illustrate why Saving and Investment tend to equality and
explain and illustrate why unemployment will not be a persistent problem
in the labor market.
The desired saving curve is shown as an upward-sloping supply curve of
savings. The equilibrating force is the interest rate. At higher interest rates,
people desire to save more. At higher interest rates, however, businesses wish
to engage less in investment because it is less profitable to invest.
Equilibrium in the labor market the demand for labor is downward sloping.
At higher rates, firms will employed fewer workers. The supply of labor is
upward sloping. At higher wage rates, more workers will work longer, and
more people will be willing to work. If an excess quantity of labor is supplied
at a particular wage level, the wage level must be above equilibrium. By
accepting lower wages, unemployed workers will quickly put back to work.
Thus this will put us back into equilibrium.
14.Describe the short- and long-run determination of equilibrium real GDP
and the price level in the Classical Model based on the LRAS.
An increase in the quantity of labor input increases real GDP.
The classical economist made little distinction between long run and short run.
Prices adjust so fast that the economy essentially always on or quickly moving
toward LRAS (which is the real GDP). Furthermore, because the labor market
adjusts rapidly, real GDP is always at or soon to be at, full employment.

The Keynesian Model: Short Run Aggregate Supply:


15.Explain the circumstances under which the short-run aggregate supply
curve may be either horizontal or upward sloping but not vertical like the
LRAS.
Keynesian model prices, especially the price of labor (wages) were inflexible
downward due to the existence of unions and long-term contracts between
business and workers. That means that the price is sticky. In such a world,
which has large amount of excess capacity and unemployment, an increase in
aggregate demand will not raise the price level, and a decrease in aggregate
demand will not cause firms to lower prices.
Short-Run Aggregate Supply (SRAS) the horizontal portion of the aggregate
supply curve in which there is excessive unemployment and used capacity in
the economy. Keynes assumed that prices will not fall when aggregate demand
falls, and that there is excess capacity, so prices will not rise when aggregate
demand increases. Thus the SRAS is simply a horizontal line at the given price
level. An increase in aggregate demand will increase the real GDP level, but
will not increase the price. A decrease is aggregate demand will decrease the
GDP level, but will not decrease the price.
16.Explain how the national economy might experience fixed or changing
price levels and output in the short run using the SRAS and shifts in AD.
If the price is at fixed level, then the SRAS curve is horizontal. However, prices
are not totally sticky, thus some price adjustments takes place in the short
run. Allowing for partial price adjustments implied that the SRAS slopes
upward, and its slope is steeper after its crosses the LRAS line. This is
because higher and higher prices are required to induce firms to raise
production of goods and services to levels that temporarily exceed full
employment real GDP.

Shifts in Aggregate Supply, Short-Run and Long-Run:


17.List and explain what factors can cause shifts in the short-run and the
long-run aggregate supply curves respectively.
Factors that cause shift in SRAS change in production input prices,
particular those caused by external events that are not expected to last forever.
For example, a hurricane that temporarily shut down a significant portion of
US oil production. The resulting drop in oil production would cause at least
temporary increase in price of this input. In this case, the SRAS will shift
toward the left, while the LRAS remains the same in place.
Consequences of Changes in AD in the Short-Run:
18.Explain and illustrate the consequence of an increase in AD and the
consequence of a decrease in AD (assuming that the SRAS and LRAS
curves are stable).
Aggregate demand shock any event that causes the aggregate demand curve
to shift inward or outward
Aggregate supply shock any event that causes the aggregate supply curve to
shift inward or outward
Recessionary gap the difference between the short-run equilibrium level of
real GDP and real GDP if the economy were operating at full employment on
its LRAS.
Inflationary gap the gap that exists whenever equilibrium real GDP per year
is greater than full-employment real GDP.
1. AD decreases when Aggregate supply is stable short-run outcome will
be a rise in unemployment rate. A reduction in aggregate demand shifts
the AD curve to the left. The difference in real GDP (which is a
reduction in real GDP) is called a recessionary gap. In effect, the
economy is in short-run equilibrium at less than full employment. With
too many unemployed inputs, input prices will begin to fall. Eventually,
the SRAS will have to shift vertically downward

AD increases when Aggregate supply is stable increase AD will shift the


demand curve to the right, and exceeds the LRAS. This is a condition of an
overheated economy, typically called an inflationary gap. The economy is at a
short-run equilibrium that is beyond full employment. In the short run, firms
will be operating beyond long-run capacity. Inputs will be working too hard.
Input prices will begin to rise. That will eventually cause SRAS to shift
vertically upward.
Explaining Short-Run variations in Inflation with the AD/SRAS/LRAS
model:
19.Explain what Demand-Pull Inflation and Cost-Push Inflation are and how
they differ. Students should be able to use the AD/SRAS/LRAS model in
doing so.
Demand-pull inflation inflation caused by increases in aggregate demand
not matched by increases in aggregate supply (Whenever the general level of
price rises in the short run because of increases in aggregate demand).
Cost-push inflation inflation caused by decreases in short-run aggregate
supply. Aggregate demand remains stable, but SRAS shift leftward, price level
will increase.
20.Explain how the appreciation or depreciation of the dollar affects the
national economy using the AD/SRAS/LRAS model.
Stronger dollar (appreciation) 2 effects, (1) lower price for import inputs,
causing a shift in SRAS outward and to the right. Equilibrium moves to lower
price level and higher equilibrium real GDP per year. (2) lower net exports,
and cause AD to shift inward. Due to this effect, equilibrium will lower price
level, and lower equilibrium GDP per year. On balance, the combined effects
of the decrease in aggregate demand and increase in aggregate supply will be
to push down the price level, but the real GDP may rise or fall
Weaker dollar (depreciation) reverse of stronger dollar. (1) higher price for
import, causing a shift in SRAS to the left. Equilibrium price will increase, and
the real GDP will lower. (2) higher net exports, cause AD to shift outward.
Will cause price level to increase, and increase in real GDP. The effect of
weaker dollar as a whole is that increase in aggregate demand, and decrease
in aggregate supply will push up the price level, but the real GDP may rise or
fall.

Chapter 12:
The Keynesian Model of Macroeconomic Activity, Basics:
21.List and explain the four simplifying assumptions of the Keynesian Model and
explain the implications of these assumptions.
1. Business pay no indirect taxes (for example sales tax)
2. Business distribute all of their profits to shareholders
3. There is no depreciation, so gross private domestic investment equals net
investment
4. The economy is closed (there is no foreign trade)
Given all these simplifying assumptions, real disposable income, or after-tax
real income, will be equal to real GDP minus net taxes taxes paid less
transfer payments received.
22.Define and explain the relationship between the following terms:
a) consumption spending on new goods and services to be used up out of a
households current income; includes such thing as buying food and going
to concert.
b) consumption goods are goods purchased by households for immediate
satisfaction.
c) saving whatever is not consumed out of spendable income. Saving is an
action measured over time (a FLOW). Savings is an accumulation
resulting from the act of saving in the past (a STOCK).
d) disposable income = consumption + savings
e) investment investment is a FLOW concept. (1) Fixed investments:
expenditures on new machines and buildings (capital goods) that are
expected to yield a futures stream of income, (2) Inventory investment:
change in business inventories.
f) capital goods producer durables; non-consumable goods that firms use to
make other goods.

g) stocks measured at a certain point or instant in time. For example, you


may have currently have savings of $8000 (a STOCK number), that are
result of 4 years of savings at a rate of $2000 per year (a FLOW).

h) flows an action that occurs at a particular rate (for example $40 per
week, or $2080 per year, this rate is a FLOW). It is expressed per unit of
time, usually a year. Consumption is also a FLOW concept, you consume
from after-tax income at a certain rate per week, per month, or per year.
The Keynesian Model, Consumption Function:
23.Explain what the Keynesian Consumption Function is, and they should be able
graph it on a graph with a 45-degree reference line and be able to interpret such
a graph.
Keynesian consumption function the real consumption and saving decisions
depend primarily on a households current real disposable income
If we plot the combinations of real disposable income and planned real
consumption, we get the consumption table.
As real income rises, planned consumption also rises, but by a smaller amount.
Planned saving also increases with disposable income. There is an income
level where planned saving is actually negative. The further the income drops
below that level, the more household engages in dissaving, either going into
debt or by using up some of its existing wealth.
break even income the income where real disposable income equals planned
real consumption. There is neither positive nor negative real saving.

24.Define, distinguish between, and explain the relationship between the following
concepts related to the Keynesian Consumption Function: a) Autonomous
Consumption, b) Average Propensity to Consume, c) Average Propensity to
Save, d) Marginal Propensity to Consume, and e) Marginal Propensity to Save.
Autonomous consumption = this amount of real planned consumption which
does not depend at all on actual real disposable income
a) Average Propensity to Consume (APC) real consumption divided by real
disposable income.
APC = real consumption / real disposable income
b) Average Propensity to Save (APS) real saving divided by real disposable
income
APS = real saving / real disposable income
c) Marginal Propensity to Consume the ratio of the change in consumption
to the change in disposable income
MPC = change in real consumption / change in real disposable
income
d) Marginal Propensity to Save the ratio of change in saving to the change
in disposable income
MPS = change in real saving / change in real disposable income

APC + APS = 1 (=100% of total income)


MPC + MPS = 1 (=100% of the change income)

The Keynesian Model, Investment Function:


25.Explain what the Keynesian Planned Investment Function is and how planned
investment is determined by the function. Students should also understand how
investment spending is included in the Keynesian 45-degree graph with
consumption spending, See Figure 12-4.
Planned Investment Function an inverse relationship between the rate of
interest and the value of planned real investment. It is a negative slope line. As
interest rate falls, more investment opportunities will be profitable, and
planned investment will be higher.
What causes the Investment Function to Shift? (1) expectation of business;
if higher profits are expected, more machines and bigger plants will be planned
for the future. More investment will be expected, so the investment function
would shift to the right. (2) Any change in productive technology; a positive
change in technology would stimulate demand for additional capital goods and
shift the investment function to the right.
The Keynesian Model, Consumption and Investment together but
excluding the Government Sector and the Foreign Sector:
26.Explain how equilibrium is determined in a simple Keynesian model that
includes only consumption spending and investment spending in the context of
the 45-degree reference line graph and the Saving and Investment graph. In
reference to both these graphs, students should also be able to distinguish
between Planned and Actual Investment and explain how unplanned changes in
business inventories affect the national economy.
Equilibrium is the point where Planned Real Consumption intersects the 45degree reference line (see Figure 12-3). At this intersection point, planned real
consumption will be exactly equal to real GDP per year.
Mismatch between Planned and Actual Investments business planned to
invest a certain amount of capital; savings by household is over and above
planned investment represent less consumption spending. The fact that
consumption is lower than planned will translate into unsold goods that
accumulate as unplanned business inventory investments. This will leave firms

with unsold products, and their inventories will begin to rise above the level
they had planned. Businesses will respond to the unplanned increase in
inventories by cutting back production of goods and services and reducing
employment, and we will move toward a lower level of real GDP.
The Keynesian Model with Government and the Foreign Sector Added:
27.Explain and illustrate (using the 45-degree reference line graph) how the
national economy comes to an equilibrium when Government Spending (G)
and Net Exports (X=exports imports) are added to Consumption Spending
and Investment Spending. Students should understand in this context what it
means to say that Investment Spending, Government Spending, and Net
Exports are autonomous from Real GDP.
Lump sum tax = a tax that does not depend on income
Net Exports (X) = exports imports
Real Consumption Function = C + I + G + X
C = consumption function with no government & no taxes
I = autonomous investment
G = government spending
X = net export
Adding government spending and foreign export increase real GDP per year
significantly.
The Keynesian Model and the Autonomous Spending Multiplier under the
assumption of a fixed Price Level (i.e., a horizontal SRAS):
28.Explain what the Multiplier Effect is and how it works in the context of Table
12-3 and Figure C-1.
Multiplier the ratio of the change in equilibrium level of real GDP to the
change in autonomous real expenditures. The number by which a change in
autonomous real investment or autonomous real consumption is multiplied to
get the change in equilibrium real GDP. For example, a permanent increase in
$100 billion in autonomous real investment spent on real GDP per year, will
eventually result in a $500 billion increase in equilibrium real GDP per year.

The multiplier effect happens because the spending of one group represents
income for another. One group will spend, and become income for another
group, which they will then spend to become the income of the next group, and
so on

29.State the two different formulas for the multiplier (First: Multiplier = 1/(1MPC) = 1/MPS; Second: Multiplier = (Ultimate change in equilibrium real
GDP)/(change in autonomous spending)) and be able to solve simple algebraic
problems involving these formulas.
Multiplier = [1 / (1 MPC)] = 1 / MPS
MPC + MPS = 1
The smaller the marginal propensity to save, the larger the multiplier
The larger the marginal propensity to consumer, the larger the multiplier.
This happens because the money needs to be spent to become the income of next
group; and the next group needs to spend to become the income of the group after
that. If everybody saves the money, the multiplier process would stop.
Change in equilibrium real GDP = multiplier x change in autonomous spending

The Keynesian Model and the Autonomous Spending Multiplier dropping


the assumption of a fixed Price Level (i.e., a horizontal SRAS) AND the
Relationship between Total Planned Expenditures (45-degree graph) and
the Aggregate Demand Curve:
30.Explain how the Multiplier works when we assume Price Level is not fixed
(SRAS slopes upward) in the context of Figure 12-7, AND the relationship
between Total Planned Expenditure (C+I+G+X) and Aggregate Demand in the
context of Figure 12-8.
An increase in autonomous spending shifts the AD curve outward to the right.
If the price level remains the same, then the short-run equilibrium level of real
GDP would increase.
However, because the price does not stay fixed, it increases with the shift of AD
to the right, the ultimate effect on real GDP is smaller than the multiplier effect
on nominal income because part of the additional income is used to pay higher
prices. Not all is spend on additional goods and services.
AD relationship to Total Planned Expenditure (C+I+G+X)
1.

A higher price level can decrease the purchasing power of any


cash that people hold. This causes consumption expenditure, C, to fall,
putting downward pressure on C+I+G+X curve

2.

Because individual attempt to borrow more to replenish their real


cash balances, interest rate will rise. Rise in interest rate reduces reduction
in total planned spending on goods and services

3.

In an open economy, higher price level causes spending on our


goods to fall. Simultaneously, it increases our demand for others goods.
There will be an increase in import, and decrease in export, thereby
reducing the size of X, which puts downward pressure on C+I+G+X curve.

Chapter 13:
Keynesian fiscal policy:
31.Define: discretionary fiscal policy, expansionary, contractionary, policy
tools.
discretionary fiscal policy the discretionary changing of government
expenditures or taxes to achieve national economics goals, such as high
employment with price stability.
expansionary liberal fiscal policy of spending more money on key economic
figures to support
contractionary conservative fiscal policy of spending less money to allow the
economy to tank
policy tools different fiscal policies that can be pursued for various goals
32.Explain how Congress can use fiscal policy to close inflationary and
recessionary gaps, changing both real GDP and the price level.
Congress can use fiscal policy to close recessionary gaps by choosing to spend
more in the economy to shift the aggregate demand curve to the right. Because
of the upward-sloping SRAS, both the price level and the real GDP rise.
On the other hand, it can close inflationary gaps by reducing its spending; this
will reduce aggregate demand, which will force equilibrium to fall real GDP
and price level will fall as well.
33.Be able to show how fiscal policy changes appear on the AD/AS graph and
determine the appropriate policy choice.

Crowding out and the Laffer curve:


34.Explain and show graphically how crowding out reduces the effectiveness of
fiscal policy.
crowding-out effect the tendency of expansionary fiscal policy to cause a
decrease in planned investment or planned consumption in the private sector;
this decrease normally results from the rise in interest rates.
Crowding out is when a rise in government spending, holding taxes constant
(deficit spending), tends to crowd out private spending, dampening the positive
effect of increased government spending on aggregate demand. In extreme
cases, complete crowding out will result in the increased government spending
having no net effect on aggregate demand; the final result is simply more
government spending and less private investment and consumption.
35.How does the Ricardian equivilence theorem explain why frequent changes
in tax rates produce very little change in consumer spending?
Ricardian equivalence theorem the proposition that an increase in the
government budget deficit has no effect on aggregate demand; in other words,
it does not matter how government expenditures are financed, whether by taxes
or by borrowing.
Frequent changes in tax rates are mirrored by consumer spending
compensations, thus having little to no effect on the economy.
36.Explain and show graphically how direct expenditure offsets will reduce
the effectiveness of discretionary fiscal policy.
direct expenditure offsets actions on the part of the private sector in
spending income that offset government fiscal policy actions. Any increase in
government spending in an area that competes with the private sector will have
some direct expenditure offset.

37.Be able to draw the Laffer curve and use it to show how supply-side
economists explain how a reduction in marginal tax rates could bring
about an increase in tax revenues.
The Laffer curve indicates that tax revenues initially rise with a higher tax
rate; eventually, however, tax revenues decline as the tax rate increases.
Fiscal policy lags:
38.Define the three fiscal policy lags (recognition, action and effect) and how
they complicate using fiscal policy to 'fine-tune' the economy.
recognition time lag the time required to gather information about the
current state of the economy.
action time lag the time between recognizing an economic problem and
implementing policy to solve it; the action time lag is quite long for fiscal
policy, which requires congressional approval.
effect time lag the time that elapses between the implementation of a policy
and the results of that policy.
The three fiscal policy lags complicate using fiscal policy to fine-tune the
economy because of the sheer amount of time it takes to implement and see the
effects of a new policy being put into place.
Automatic stabilizers:
39.Be able to identify the automatic stabilizers and explain how they minimize
changes in the GDP.
automatic/built-in stabilizers special provisions of certain federal programs
that cause changes in desired aggregate expenditures without the action of
Congress and the president; examples are the federal progressive tax system,
unemployment compensation, income transfer payments, and food stamps.
What Do We Really Know about Fiscal Policy?
40.When is fiscal policy most likely to be effective? Least likely? Why?
during normal times not very effective - Congress does too little too late to
help in a minor recession; automatic stabilizers rather than fiscal policy.

during abnormal times very effective can stimulate aggregate demand as


well as increase real GDP through the output of new goods and services.

Chapter 14
1. Know the differences between a federal budget deficit, a surplus, and a balanced budget.
Federal budget deficit = government budget deficit. If government spends more than it
receives in taxes during a given period of time. This is called a deficit. In order to cover the
shortfall of the budget (deficit), the government sells IOUs, called Treasury Bonds, to people.
Whoever bought bonds will receive interests from the US government.
Federal budget balanced = balanced government budget. If the government spends an
amount exactly equal to the revenues it collects in taxes during a given period of time.
Federal budget surplus = government budget surplus. If the government spends less than
the revenues it receives in taxes during a given period.
2. Explain the difference between the federal budget deficit and the national debt.
Federal budget deficit is the amount of shortfall (debt) in $$ over a given period of time.
National debt = public debt. This is the total value of all outstanding debt of the federal
government accumulated over all time. It includes all deficit & surplus & balance
periods. So if the government has budget deficit, then the national debt increases, if the
government has surplus, then the national debt decreases.
3. Calculate the effects of spending and taxing on the deficit and debt.
Government spending more than it can collect taxes increase in deficit, and this
increase national debt.
4. Know the historical trend in the U.S. budget deficits and the national debt.
Figure 14.1 and 14.2 showed that the US has annual budget surplus of 13 years since
1940. Most of the time it is has budget deficit and needs to borrow money (IOU).

There is a resurgence of federal government deficit since 2000 due to increase in


spending and tax cut (which reduces money the government can take in to spend)

5. Know the difference between the gross national debt and the net national debt.
Gross national debt = all federal public debt taken together
Net national debt = gross national debt money the Federal government owes to itself.
Gross national debt minus all government interagency borrowing. For example, Social
Security Agencies owes US Treasury bond, thus the Federal is paying Social Security
Agency (itself).

6. Understand the burdens the national debt puts on future generations, particularly
pertaining to the effects of high interest rates and debt owned by foreigners.
Table 14.1 showed federal budget deficit, net public debt (net national debt), per capita
net public debt (national debt per person living in US), net interest payment per year, and
net interest as percentage of GDP (Gross Domestic Product). The net public debt as GDP
fell steady after WWII, and then increases steadily after 2000 (around 50% of GDP).
US government must pay interests on money it owes due to Treasury Bonds. The foreign
residents, businesses, and government agencies hold more than 50% of the US net
national debt. So the US must pay interests to foreigners also.
If the government continue to issue bonds (IOU) without reducing spending or increasing
taxes now, then the National debt can be paid by increase taxes for future generations
because of the increasing in interests due to increasing in national debt.
The rise in interest rates (high interest rates) will cause a reduction in the growth of
investment and capital formation, which in turn slows the growth of productivity and
improvement in societys living standard. This is called a crowding-out effect. In a
close society. Deficit spending increases the total demand for credit but leaves the total
supply of credit unchanges. Thus a reduction in privates investment and capital is
necessary.
For debt owes to the foreigners, future generation will have to pay back the debt +
accumulated interests. Portions of the incomes of the US residents will then be
transferred abroad. However, if the rate of return of government-funded projects with
deficits EXCEEDS the interest rates paid to foreigners, then the future US residents will

be better off. However, if the government is wasting the money, then the future residents
will be worst off.

7. Explain the relationship between the government budget deficit and the trade deficit.
US trade deficit = the value of US imports of goods and services exceeds the value of its
exports (will often accompany a government budget deficit)
When a foreigner purchase new US government bond (due to a budget deficit), they will
have fewer dollar to spend on US items (including US export goods). Hence when the US
government operates with a budget deficit, we should expect to see the foreign dollar
holders spending more on buying US government bonds and less on US produced goods
and services. As a consequence of the US government deficit, therefore, we should see a
decline in US exports relative to US imports (i.e. higher US trade deficit)

8. Understand the long-run and short-run effects the deficits and debt have on real GDP.
Short-run effect. When there is a recession-gap, the increase in aggregate demands (due
to increase expenditure of a budget deficit) can eliminate the recession gap and pushes
the economy toward its full employment real GDP level. Howerver, if the economy is at
full employment real GDP level, an increased in total planned expenditure and higher
demand generated by the deficit will create an inflationary gap (i.e. price level increases)
Long-run effect. In the long-run equilibrium real GDP is unaffected in the face of
increased government deficits. Ultimately, government spending in excess of government
receipts simply redistributes a larger share of the real GDP per year to governmentprovided goods and services. Thus if the government operates with a higher deficits over
an extended period, the ultimate results is a shrinkage in the share of privately provided
goods and services (i.e the government takes up a larger portion of economic activity)

9. Explain what is necessary for meaningful deficit reduction.


Increase tax to reduce deficit. (1) Increase taxes for everyone, and (2) increase taxes for
the rich more.
Reduce expenditures to reduce deficit. (1) reduce military spending, (2) reduce
entitlement (Social Security, Medicare, and other Health programs such as Medicaid).
These are also called noncontrollable expenditures.

10. Understand the impact of entitlement spending on deficits and the debt.
Todays entitlement expenditures is 1/3 of total federal spending. It is now exceed all
other domestic spending. Entitlements are growing faster than any other parts of the
federal government budget. Entitlement grew 7% - 8%, while the economy grew less
than 3% per year. The federal deficit is not expected to drop in the near future because
entitlement programs are not likely to be eliminated.

Chapter 15
11. Define and explain the four functions of money.
1. Money as a medium of exchange: sell/buy. Sellers accept money as payment.
Otherwise would need to barter: both people must exchange something that the
other wants
2. Money as a unit of accounting: it is a common denominator that people
recognized as a measure of value. It is a yardstick to allows individuals to easy
compare the relative value of good and services. It is a central value of money.
3. Money as a store of value: The ability to hold value over time. The money you
have today can be used to buy things later in the future
4. Money as a standard value of deferred payment: It is used to settle debt in the
future. Bonds can be paid in the future (due at maturity)

12. Identify the key properties that any good that functions as money must possess especially
in a fiduciary monetary system.
1. Accountability: people will accept them in exchange for good and services.
People are accepting money because they have confidence that they can be later
exchange for something else
2. Predictability of value: money retains its usefulness even if its purchasing power
is declining year in and year out as during periods of inflation. People will not
necessary refused to accept money in exchange simply becae you know that its
value will define due to inflation next year

13. Define liquidity. Explain which assets are liquid, which are not, and why not.
Liquidity: the degree to which an asset can be acquired or disposed of without
much danger of any intervening loss in nominal value and with small transaction
loss.
Most liquid = Currency and coins
Transactions deposits
Certificate of deposits (CD)
Stocks and bonds
Cars
House
Old masters paintings
Commercial office buildings
Least liquid = Antique furniture

14. Define the transactions (M1) and liquidity (M2) approaches to defining money making
sure you know which components are in which definition.

1. Transaction approach (M1) = a way of looking at money as a medium of


exchange. M1 is the money supply, measured as the total value of currency plus
transactions deposits plus travelers checks not issued by banks.
Transactions deposits = debit cards and checks
Travelers can be issued by American Express and other institution
M1 = Currency and coins + Transaction deposits + Travelers check
2. Liquidity approach (M2) = view money as a temporary store of value, so it
includes M1 plus all other highly liquid assets.
Small-denomination time deposit = funds must be left in a financial institution for
a given period before they can be withdrawn without penalty.
M2 = M1 + saving deposits + small-denomination time deposit + Money market
mutual fund balances + non-institution money market mutual funds
15. Explain how financial intermediaries lower transactions costs, and define: "direct
financing," "indirect financing," "risk," "moral hazard," "asymmetric information,"
"assets," and "liabilities."
Financial intermediaries (banks and savings institutions) = transferring funds between
from savers to investors. It makes it possible for many people to pool their funds,
therefore increasing their size (or scale) of the total amount of savings managed by an
intermediary. This centralization of management reduces cost and risks. Examples are
pension funds, investment companies.
Direct financing: people lend funds directly to a business. When an individual choose to
hold some of their savings in new bonds issued by a corporation, their purchases of the
bonds are in effect direct loans to the business.
Indirect financing: Individual may choose to hold a time deposit at a bank (CD), the bank
may then lend to the same company. This way the same people can provide indirect
financing to the business.
Risk: money lending to a business can lose value
Asymmetric Information: Information possessed by one party in a financial transaction
but not by the other party. For example, business may have better knowledge of its own
current and future prospect than the potential lenders. For example, the business may
know that it is borrowing money for a high risk projects that they may not be able to
repay the loan.

Moral hazard: the possibilities that a borrower might engage in behavior that increases
risk after borrowing the funds. For example, the business borrowed money for a low risk
project, but then switch to a high risk project after they get the money.
Liabilities: Amounts owed. The legal claims against a business or household by nonowners
Assets: Amount owned. All items to which a business or household holds legal claim

16. Explain how the Fed is organized, who is included on the Board of Governors and the
Federal Open Market Committee, and the structure and function of the district banks as
well.
Fed = Federal Reserve System. The central bank of US.
(1) Fed is managed by Board of Governors, composed of 7 full-time members
appointed by the US president with the approval of the Senate for a 14
years term
1. Set reserve requirements and approved discount rates as part of
monetary policy
2. Supervises and regulates member banks and bank holding
companies
3. Establish and administers protective regulations in consumer
finance
4. Oversees Federal reserve banks

(2) Board of Governors supervised the 12 Federal Reserve district banks


(which have a total of 25 branches).
1. District banks:

1. Proposed discount rates


2. Hold reserve balances for depository institutions and lend
to them at the discount window
3. Furnish currency
4. Collect and clear checks and transfer funds for depository
institutions
5. Handle US government debts and cash balances
(3) Federal Open Market Committee: includes Boards of Governors and 5
reserve bank president (1 is always from New York, the other 4 are
rotating)
Direct open market operations: buying and selling existing US
government securities, the primary instruments of monetary policy.

17. List and explain the functions of the Fed and who is responsible for each function?

1. Fed supplies the economy with fiduciary currency: It provided the economy with
cash (i.e dollar bill). It can print money.
2. Fed provides payment-clearing system: Federal Reserves offers check-clearing
services to commercial banks. For example: when a bank extends a loan to
another institution, it typically transmits the payment using Fedwire. The other
institution repays the loan the next day or few days later by transmitting payment
on the same system.
3. Fed holds depository institutions reserves: the 12 Federal Reserve district banks
hold the reserves of depository institutions. Depository institutions are required
by law to keep a certain percentage of their transaction deposits as reserves.

4. Fed acts as the governments fiscal agent: The government collects large sum of
funds through tax, and spends/distribute equally large sum through an account
with the Federal Reserve. Thus the Fed acts as the governments banker
5. Fed supervised depository institutions: Fed and other regulators periodically and
without warning examine depository instructions to see what kind of loans being
made, and who has receives them. To make sure that the banks are conformed to
banking rules
6. Fed conducts monetary policy: regulate the nations money supply.
7. Fed intervenes in foreign currency markets: sometimes the Fed attempts to keep
the value of the dollar from changing. It does this by buying and selling US
dollars in foreign exchange markets.
8. Fed acts as lenders of the last resort: sometimes and individual bank may be
temporarily low on cash and other liquid assets (i.e illiquid). The Fed can lend to
any temporarily illiquid but other healthy banks. In this way the Fed can restore
depositors confidence.

18. Explain the process through which the Federal Reserve controls the money supply in a
fractional reserve banking system.
Fractional reserve banking system: a system in which depository institutions hold
reserves that are less than the amount of total deposits.
In a fractional reserve banking system, banks do not keep sufficient funds on hand to
cover 100% of their depositors account. Instead, the funds are held as reserves in the
form of cash in banks vault and deposits that banks hold on deposit with Federal Reserve
district banks.

Under fractional reserve banking system, the Fed can add to the quantity of money in
circulation by bringing an expansion of deposits within the banking system by
selling/buying existing US government securities in the open market. For example, Fed
bought $100,000 of US bonds from Bank1, bank1 now can use that $100,000 for loan to
individual (minus the reserved amount). That individual now can deposit that amount to
bank 2, which bank 2 can used that as a loan to another individual and so on. Each banks
receives smaller and smaller amount, but the total money expansion (close to 1 Million)
is much larger than the original $100,000 that the Fed paid to Bank1. In this example, the
Fed spent $100,000 but inject $1M into the money supply.
19. Define the money multiplier and specify it in two functional forms.
Money multiplier = a number that when multiplied by a change in reserves in the
banking system, yields the resulting change in the money supply. The money
multiplier gives the change in the money supply due to a change in reserves.
(1) Potential vs. actual money multipliers: potential money multiplier is the
maximum possible value of money multiplier.

1. Potential money multiplier = 1/reserve ratio


For example if reserve ratio = 10%, then the potential
multiplier is 10

(2) Real-world money multiplier: M1 multiplier usually between 1.5 and 2.0.
M2 multiplier usually about 5

20. Explain the central features of federal deposit insurance, how it can prevent bank runs,
and how its activities can affect asymmetric information and moral hazard.
FDIC (Federal Deposit Insurance Corporation) = a government agency that insures the
deposits held in banks and most other depository institutions.
Bank runs = when many depositors simultaneously rush to their banks to withdraw their
deposits. Banks do not hold enough reserves for everybody.

FDIC provided assurance that the depositors money is insured by the Federal
government. If the bank fails, then the Fed will return money to each depositors. This
gives the depositors the reason to keep their money in the bank without worry about
doing a bank rush to get their money out in a hurry.
The FDIC charged banks premiums based on their total deposits, and this went into a
fund that would reimburse depositor in case of a bank failure.
Asymmetric information = a hazard created by FDIC. When insurance is involved,
people would disguise the fact that they are poor risks. Deposit insurance shields
depositors from the potential adverse effects of risky decisions and so make depositors
willing to take riskier investments strategies from their bank
Moral hazard = insured depositors know that they will not suffer loss if their banks fails.
So they have little incentive to monitor their banks investments activities. Thus their
banks have incentives to take more risks than they otherwise would.

CHAPTER 16
The Demand for Money
21.Explain the three categories of money demand and understand how money
demand responds to changes in iterest rates and GDP and how these
changes are depicted on the money demand graph.
To use money, one must hold money.

(1) Money demand 1: The transaction demand. The main reason


that people hold money is that money can be used to purchase
goods and services, but they wish to make purchases more or less
continuously. The benefit they receive is convenience: they
willing to forgo interest earnings in order to avoid the
inconvenience of cashing in non-money asset every time they want
to buy something. As nominal GDP rises, people will want to hold
more money because they will be making more transaction.
(2) Money demand 2: The Precautionary demand. People hold
money to make unexpected purchases or to meet emergencies.
The higher the interest rate, the lower the precautionary money
balances people wish to hold.
(3) Money demand 3: The asset demand. People choose to hold
money rather than other assets for 2 reasons: its liquidity and
lack of risk.
The disadvantage of holding money balances as an asset is losing the interest
earnings.

How the Fed Influences Interest Rates


22.Explain how the Fed's Open Market Operations influence interest rates
and hence bond prices.
The market price of existing bonds (and all fixed-income assets) is inversely
related to the rate of interest prevailing in the economy. An increase in the
prevailing interest rate in the economy will cause the market value of existing
bond to fall.

As a consequence of the inverse relationship between the price of existing


bonds and the interest rate, the Fed is able to influence the interest rate by
engaging in open market operations. A Fed open market sale reduces the
equilibrium price of bonds bring about an increase in interest rate. A Fed
open market purchase that boost the equilibrium price of bonds generates a
decrease in interest rate.
If the Fed sells bonds, then the price of bond will decrease, because it will sell
at a lower price than exists in the open market. If the Fed buys bonds, then the
price of bond will increase because it needs to buy at higher price than exists
in the open market.
Effects of an Increase in the Money Supply
23.Explain the direct and indirect effects of monetary policy on short run AD.
Include both expansionary and contractionary changes and the use of
various policy tools.
Quantitative easing Federal Reserve open market purchases intended to
generate an increase in bank reserves at a nearly zero interest rate.
Direct effect of an increase in money supply when people have excess
money balances, they will go out and spend them on goods and services.
Hence, they have a direct impact on aggregate demand (AD).
Indirect effect of an increase in money supply not everybody will
necessarily spend the newfound money on goods and services; some may wish
to deposit a portion or all of these excess money in the bank. Now the banks
have excess reserves, so they lend out money for businesses. Individual
consumers will go out and spend money on goods and services, while
businesses will engage in new investments with the excess funds from the bank.
In both ways, the increased loans generate a rise in aggregate demand.

Open Economy Transmission of Monetary Policy


24.Explain how will monetary policy affect net exports and the foreign
exchange rate?
The Fed can engage in an Expansion monetary policy causes interest rate to
fall. Such a decrease will induce international outflows of funds, thereby

reducing the international value of the dollar (i.e. a Dollar depreciation, the
dollar is cheaper), and making US goods more attractive abroad. The net
export effect of expansionary monetary policy will be the same direction as the
monetary effect, thereby amplifying the effect of such policy.
The fall of US dollars maker US exports less expensive for the rest of the world
(i.e. the rest of the world pay less in US dollar for the same good);
consequently, foreign residents demand a larger quantity of our exports as we
therefore demand fewer imports.
The Fed can also engage in Contractionary Monetary Policy. The effect is
the reverse of the Expansion monetary policy.
Monetary Policy and Inflation
25.Define the equation of exchange? Be able to define all four variables.
equation of exchange the formula indicating that the number of monetary
units time the number of times each unit is spent on final goods and services is
identical to the price level times real GDP
MsV = PY = Nominal GDP
Ms = actual money balances held by the nonbanking public/money
supply
V = income velocity of money, which is the number of times (avg. per
year), that monetary unit is spent on final goods and services.
P = price level or price index
Y = real GDP per year
26.List the assumptions made to turn the equation of exchange into the
quantity theory of money? What does this theory predict?
Equation of exchange = states that the total amount of funds spent on final
output, MsV, is equal to the total amount of funds received for final output,
PY.
The following assumptions: (1) the velocity of money V is constant, and the real
GDP, Y is also constant, then the simple equation of exchange tells us that a

change in the money supply can lead only to an equiproportional change in the
price level.
Monetary Policy in Action: the Transmission Mechanism
27.Explain both expansionary and contractionary monetary policy using the
three graph transmission mechanism.
Fed can influence interest rates only by actively entering the market for federal
government securities (Treasury bonds): (1) If the Fed wants to raise interest
rate, it essentially must engage in contractionary open market operations. It
must sell more Treasure securities than its buys, thereby reducing the total
reserves in the banking system, and hence, the money supply. (2) if the Fed
wants to reduce interest rate, it must engage in expansionary open market
operations. It must buy more Treasury securities, and thus increasing reserves
and the money supply.
See Figure 16-7 (three graph transmission mechanism). An increase in
money supply will result from increase in planned investment, this in turns
will shift the aggregate demand curve (AD) outward and to the right.

Targeting the Federal Funds Rate (and other rates)


28.Explain:
a. which three interest rates are particularly relevant to carrying out
monetary policy;
1. The Federal Funds Rate depository institutions that borrow in the
federal funds market pay an interest called federal funds rate. Because
the federal funds rate is a ready measure of the cost that banks must

incur to raise funds, the Federal Reserve often uses that as a yardstick
by which to measure the effect of its policies.
2. The Discount Rate When the Fed does lend reserves directly to
depository institutions, the rate of interest that it charges is called the
discount rate. When depository institution borrow reserves from the Fed
at this rate, they are said to be borrowing through the Feds discount
window.
3. The Interest Rate on Reserves The Fed can pay interest on both
required reserves and excess reserves of depository institutions.
b. the role of the FOMC and the Trading Desk in carrying out monetary
policy;
FOMC Directive a document that summarize the Federal Open Market
Committees general policy strategy, established near-term objective for the
federal funds rate, and specifies target ranges for money supply growth.
The Trading Desk the FOMC leaves the task of implementing the Directive
to officials who manage an office at the Federal Reserve Bank of New York
known as the Trading Desk.
c. the role of the Taylor Rule in carrying out monetary policy.
Taylor Rule an equation that specifies a federal funds rate target based on
an estimated long-run real interest rate, the current deviation of the actual
inflation rate from the Federal Reserves inflation directive, and the gap
between actual real GDP per year and a measure of potential real GDP per
year. Taylor rules recommendations for federal funds rate target values
come close to the actual targets the Fed has selected over time.

Credit Policy at Today's Fed


29.Explain what "credit policy" is at today's Fed, how it operates, and
arguments for and against it.

Credit policy Federal Reserve policymaking involving direct lending to


financial and nonfinancial firms. Under the Credit policy, the Fed directly
extends credit to specific banks, other financial intermediaries, and even
nonfinancial firms.
Feds credit policy results in activities more closely resembling those of private
banks than a central bank. Like a private banking institution, the Fed extends
credit by lending out funds that it obtains from depositors. Unlike private
banks, the Fed holds deposits of banking institutions instead of deposits from
households and firms.
Arguments for Feds credit policy:
(1) Giving banks time to recover from the Financial Meltdown,
(2) Making Financial Markets and Institutions more liquid and solvent,
(3) Contributing to International Financial Liquidity
Arguments against Feds credit policy:
(1) Providing an incentive for Institution to operate less efficiently,
(2) Reducing incentives to screen and monitor in order to limit
asymmetric information problem,
(3) make monetary policy less effective

Appendix E: Monetary Policy--A Keynesian Perspective


30.Understand the Keynesian approach to an increase and decrease in the
money supply and its effects on the interest rate and the GDP.

According to the traditional Keynesian approach to monetary policy, changes


in the money supply can affect the level of aggregate demand only through
their effect on interest rates. Moreover, interest rate changes act on aggregate
demand solely by changing the level of real planned investment spending.
An increase in money supply increases real GDP by lowering interest rates
and thus increasing investment (Figure E-1). The rise in investment
spending causes real GDP to rise, which in turn causes real consumption
spending to rise, further increase real GDP.
A reduction in money supply pushes interest rates up. Firms respond by
reducing their investment spending, and this pushes real GDP downward.
Consumers react to the lower real GDP by scaling back on their real
consumption spending, which further depresses real GDP. Thus, the ultimate
decline in real GDP is larger than the initial drop in investment spending.

Chapter 17:
Active Versus Passive Policymaking
31. Define active and passive policymaking. Why would policy makers prefer one or the
other?

Active (discretionary) policymaking all actions on the part of monetary and


fiscal policy makers that are undertaken in response to or in anticipation of
some change in the overall economy.
Passive (nondiscretionary) policymaking policy making that is carried out in
response to a rule. It is therefore not in response to an actual or potential
change in overall economic activity.
Proponents of passive policy argue that fiscal policy time lags often render
short-term stabilization policy ineffective, or it can also make it worst.

Natural Rate of Unemployment


32. Define the natural rate of unemployment, cyclical, structural, frictional.

Cyclical unemployment unemployment causes by either inflation or


recession
Natural rate of unemployment = structural unemployment + frictional
unemployment
Structural and frictional unemployment both exists even when the economy is
in long-run equilibrium.
During recession, the overall unemployment rate exceeds the natural rate. So
cyclical unemployment is positive. During economic booms, the overall
unemployment rate can go below the natural rate. At such times, cyclical
unemployment is positive.
33. Show how expansion and contractionary policy changes (either fiscal or monetary)
affect the AD-AS graph, including both short run and long run changes.
See Figures 17-2, and 17-3
1. Figure 17-2: An expansion monetary or fiscal policy shifts AD curve outward.
The SRAS shifts right also, and price increase. Unemployment curve rate is now
below its natural rate at short-run equilibrium point. As expectations of input
owners are revised, SRAS curve shifts left, which causes price to increase. The
price level will increase to what LRSA expected, and the unemployment rate
returns to natural state
2. Figure 17-3: A decline in AD shift the AD curve to the left, and leads to a lower
price level and real GDP declines. The unemployment rate will rise above the
natural rate of unemployment. And the lower price level, the expectations of input
owners are revised, and SRAS shifts right. The price level will decrease to what
LRSA expected, and the unemployment rate returns to natural state.
34. Sketch a graph of the short run Phillips curve and explain its policy implications.
35. Explain the importance of expectations as they relate to the Phillips curve and what
changes Phelps and Friedman proposed to Phillips work.
If activist policymakers attempt to exploit the apparent trade-off in the Phillips curve,
according to economists who support passive policymaking, aggregating demand will no
longer move up and down in an unpredictable way.

Rational Expectations and Policy Irrelevance Proposition

36. Define rational expectations and explain the short run and long run policy
implications of anticipated vs. unanticipated policy changes.
rational expectations a theory stating that people combine the effects of past policy
changes on important economic variables with their own judgment about the future
effects of current and future policy changes.
37. What is policy irrelevance, and how does it relate to rational expectations? What is
the relationship between expectations and SRAS?
policy irrelevance proposition the conclusion that policy actions have no real effects in
the short run if the policy actions are anticipated and none in the long run even if the
policy actions are unanticipated.
SRAS will shift as a result of consumer expectation and actions in regards to future
occurrences.
Another Challenge to Policy Activism
38. Explain the real business cycle theory and supply shocks. Be able to illustrate both
harmful and beneficial supply shocks on the AD-AS graph.
Real, non-monetary forces might help explain aggregate economic fluctuations; these
shocks may take various forms, such as technological advances that improve
productivity, changes in the composition of the labor force, or changes in availability of a
key resource.
Modern Approaches to Rationalizing Active Policymaking
39. Understand the Keynesian justifications for active policymaking: menu costs, sticky
prices and wages and bounded rationality.
small menu costs costs that deter firms from changing prices in response to demand
changes; for example, the costs of renegotiating contracts or printing new price lists.
sticky prices prices, especially wages, that remain inflexible in the short run

Is There a New Keynesian Phillips Curve?

40. Explain what is meant by the New Keynesian Phillips Curve and distinguish which
beliefs about how the economy functions would lead an economist to advocate active
or passive policymaking.
The New Keynesian Phillips Curve suggests that sticky prices strengthen the argument
favoring active policymaking as a means of preventing substantial short-run swings in
real GDP and, as a consequence, employment.

EXAM1:

Chapter 1
After reading this chapter, you should be able to:

1. Define economics and understand the importance of the fact that there are
unlimited wants but only limited resources available to satisfy them.
2. Distinguish the difference between microeconomics and macroeconomics.
3. List and discuss the three basic economic questions every society must
answer and the two antithetical answers to these questions of which existing
societies are a mixture.
4. Understand the importance of rationality in economic analysis.
5. Understand what economics means be self interest and the important role it

plays in economic models.


6. Explain the importance of models and understand the role of assumptions in
economic models.
7. Understand the concept of behavioral economics and bounded rationality.
8. Distinguish the difference between positive and normative economics.
9. Know how to construct a graph.
10.Distinguish the difference between direct and inverse relationships.

Chapter 2
After reading this chapter, you should be able to:
11. Define and understand of the concept of scarcity.
12.Explain and distinguish between the factors of production.
13.Understand the difference between wants and needs and the concept of
economic goods.
14.Explain the idea of opportunity cost.
15.Draw a graph a production possibilities curve.
16.Discuss the idea of efficiency and inefficiency
17.Understand the idea of increasing additional cost.
18.Discuss economic growth and the trade-off between consumption and capital
goods.
19.Explain absolute and comparative advantage.
20.Discuss specialization, division of labor and trade between nations.

Chapter 3
After reading this chapter, you should be able to:
21.Explain the law of demand.
22.Discuss the difference between money prices and relative prices.
23.List and explain the other determinants of demand besides the price of the
good or service.
(The following learning objective is listed twice to indicate that there will be
two questions on this topic.)
24.Understand the difference between changes in the quantity demanded and
changes in demand.
25.Understand the difference between changes in the quantity demanded and
changes in demand.
26.Explain the law of supply.
27.Understand the determinants of supply.
28.Distinguish between changes in the quantity supplied and changes in supply.
(The following learning objective is listed twice to indicate that there will be
two questions on this topic.)
29.Understand the process of determining market equilibrium quantity and
equilibrium price.
30.Understand the process of determining market equilibrium quantity and
equilibrium price.

Chapter 4
After reading this chapter, you should be able to:

31.Discuss the essential features of the price system.


(The following learning objective is listed twice to indicate that there will be

two questions on this topic.)


32.Evaluate the effects of changes in demand and supply on the market
equilibrium price and quantity.
33.Evaluate the effects of changes in demand and supply on the market
equilibrium price and quantity.
34.Understand the various methods of rationing.
35.Explain the effects of price ceilings.
36.Discuss the economics of rent control.
37.Explain the effects of price floors.
38.Understand agricultural price supports.
39.Understand the economics of the minimum wage.
40.Discuss the various types of government-imposed quantity restrictions on
markets.

EXAM2:

Chapters 5 & 6
After reading Chapters 5 & 6, you should be able to:
CHAPTER 5
1. Explain how market failures such as externalities might justify the economic functions
of government.
2. Distinguish between private goods and public goods and explain the nature of the freerider problem.
3. Describe political functions of government that entail its involvement in the economy.
4. Analyze how Medicare affects the incentives to consume medical serives.
5. Explain why increases in government spending on public education have not been
associated with improvements in measures of student performance.
6. Discuss the elements of the theory of public choice.
CHAPTER 6
7. Distinguish beteen average tax rates and marginal tax rates.

8. Explain the stucture of the U.S. income tax system.


9. Understand the key factors influencing the relationship between tax rates and the tax
revenues governments collect.
10. Explain how the taxes governments levy on purchses of goods and services affect
market prices and equilibrium quantities.

Chapter 7
After reading Chapter 7, you should be able to:
The Macroeconomy: Unemployment, Inflation & Deflation, and the Business
Cycle Unemployment:
11. Answer the following:
a) name the government bureau responsible for unemployment data and the
employment categories its uses in doing so, and
b) describe the history of the unemployment rate since 1890.
12. Answer the following:
a) list the four categories an unemployed individual might fall into according to the
Bureau of Labor Statistics,
b) define what is meant by a discouraged worker, and
c) explain why knowing the average duration and costs of unemployment is important.
13. Be able to calculate the unemployment rate or the labor force participation rate from
given data.
The Major Types of Unemployment and the Concept of Full Employment (also
know as the Natural Rate of Unemployment):
14. List and describe the three major types of unemployment according to economists.
15. Define what is meant by full employment and by the natural rate of unemployment and
how they relate to the four types of unemployment is learning objective 4.
Price stability and price indices:
16. To do the following:
a) differentiate inflation from deflation and explain how each affects the purchasing
power of money, and
b) list and describe the various price indices published by the U.S. government.

17. To be able to measure inflation with a price index, with a good understanding of how
the different price indices work.
Inflation's impact on the economy:
18. To do the following:
a) explain the difference between anticipated and unanticipated inflation,
b) explain the relation between the nominal interest rate and the real interest rate.
19. Explain how inflation affects people and what economists think is the main cost of
inflation.
Business Fluctuations:
20. Explain what is meant by business fluctuations, list the phases of the business cycle,
and give an overview of the history of business fluctuations in the United States since
1880.

Chapter 8
Measuring the Economy's Performance: GDP
After reading Chapter 8, you should be able to:
The Circular Flow of Income and Output:
21. To do the following:
a) define what is meant by National Income Accounting,
b) reproduce the circular flow of income and output correctly labeling all actors,
markets, and flows, and
c) explain why profits are a cost of production.
22. To do the following:
a) discuss what is exchanged in the product markets and in the factor markets, and
b) explain why dollar value of all output must equal total income.
GDP defined:
23. To do the following:
a) give the definition of GDP,
b) explain why it is a flow concept and not a stock concept,
c) identify two main methods of measuring it, and
d) explain why intermediate goods are not included in the definition using the idea of

value added.
24. List all other transactions that are not included in GDP and explain why they are not
included.
Limitations of GDP:
25. Explain some of the limitations of GDP and why GDP is often not an accurate measure
of national well-being.
Calculating GDP by the expenditure approach:
26. To do the following:
a) list the components that comprise the expenditure approach to measuring GDP, and
b) explain what is contained in each component.
27. Explain how depreciation (capital consumption allowance) connects GDP to NDP and
gross private domestic investment to net investment.
Calculating GDP by the income approach:
28. To do the following:
a) list the components that comprise the income approach to measuring GDP,
b) explain what is contained in each component,
c) be able to list the other three measures of national income besides GDP and NDP,
and
d) show how all five are related to one another.
Nominal GDP vs. Real GDP:
29. To do the following:
a) distinguish between nominal GDP and real GDP,
b) explain why the distinction matters, and
c) be able to correct nominal GDP for changes in the price index (the GDP deflator).
Comparing GDP per capita of different countries:
30. To do the following:
a) discuss why using purchasing power parity when converting one countrys GDP into
the currency value of another county is preferred to using the current exchange rate,
and
b) be able to describe the per capita GDP of the U.S. as it compares to other countries
using both approaches.

Chapter 9
After reading Chapter 9, you should be able to:
Economic Growth:
31. Explain what is meant by economic growth.
32. To do the following:
a) discuss historical record of economic growth in the U.S.,
b) describe the ranking of the twelve countries growth rates listed in Table 9-1 from
1970 to 2011, and c) discuss criticisms of economic growth
Small differences in growth rates add up over time:
33. Explain why small differences in growth rates between countries can add up to big
differences over the long term and be able to use Table 9-3.
Traditional sources of economic growth:
34. Explain how increased productivity contributes unambiguously to greater annual
increases in a nation's per capita GDP.
35. Explain why saving is such an important determinant of economic growth. (Figure 93)
36. Describe the importance of more labor, increased capital, and improved human capital.
New Growth Theory:
37. Explain how new growth theory differs from traditional growth theory.
38. Explain the connection of innovation, patents, knowledge, new ideas, improved human
capital, an open economy, and R&D to advancements in technology.
Population and economic development:
39. To do the following:
a) discuss the relationship between immigration and economic growth,
b) explain Thomas Malthus' theory of the relationship between population growth and
standards of living, and
c) explain what the world has discovered about the relationship between economic
growth and population growth.
40. List and explain the four factors that seem to be highly correlated to the pace of

economic development.

EXAM3:

Chapter 10
After reading Chapter 10, you should be able to:
Long Run Aggregate Supply and Economic Growth:
1. To do the following:
a) draw a sketch of a long run aggregate supply curve (LRAS), and
b) discuss the relationship between the production possibilities curve and the LRAS
curve.
2. Explain why the long run aggregate supply curve has the shape that it has and its
meaning to economic analysis.
3. Illustrate economic growth with a PPC and with a LRAS curve and list the sources of
that growth.
The Aggregate Demand Curve:
4. Draw a sketch of the aggregate demand (AD) curve and discuss its meaning to
economic analysis.
5. Explain the impact of price level changes on the quantity demanded of all output with
the use of the real balance effect, the interest rate effect, and the open economy effect.
6. Discuss what factors can cause a shift of the AD curve to the right (an increase in AD)
and what factors can cause a shift of the AD curve to the left (a decrease in AD).
Long Run Macroeconomic Equilibrium:
7. Explain how to use the model of the LRAS curve with the AD curve to determine
macroeconomic equilibrium and to further explain what happens if the price level is
not at the equilibrium level.
LRAS/AD Model, Economic Growth, and the Price Level:
8. Explain how economic growth can lead to deflation using the LRAS/AD model.
LRAS/AD Model and Inflation:
9. Use the LRAS/AD model to illustrate and explain supply side inflation.
10. Use the LRAS/AD model to illustrate and explain demand side inflation.

Chapter 11
After reading Chapter 11, you should be able to:
The Classical Model of Macroeconomic Activity:
11. Explain who the Classical Economists were, state what Say's Law is and explain what
it means.
12. List the four assumptions of the Classical Model and explain the implications of these
assumptions.
13. Explain and illustrate why Saving and Investment tend to equality and explain and
illustrate why unemployment will not be a persistent problem in the labor market.
14. Describe the short- and long-run determination of equilibrium real GDP and the price
level in the Classical Model based on the LRAS.
The Keynesian Model: Short Run Aggregate Supply:
15. Explain the circumstances under which the short-run aggregate supply curve may be
either horizontal or upward sloping but not vertical like the LRAS.
16. Explain how the national economy might experience fixed or changing price levels
and output in the short run using the SRAS and shifts in AD.
Shifts in Aggregate Supply, Short-Run and Long-Run:
17. List and explain what factors can cause shifts in the short-run and the long-run
aggregate supply curves respectively.
Consequences of Changes in AD in the Short-Run:
18. Explain and illustrate the consequence of an increase in AD and the consequence of a
decrease in AD (assuming that the SRAS and LRAS curves are stable).
Explaining Short-Run variations in Inflation with the AD/SRAS/LRAS model:
19. Explain what Demand-Pull Inflation and Cost-Push Inflation are and how they differ.
Students should be able to use the AD/SRAS/LRAS model in doing so.
20. Explain how the appreciation or depreciation of the dollar affects the national economy
using the AD/SRAS/LRAS model.

Chapter 12
After reading Chapter 12, you should be able to:
The Keynesian Model of Macroeconomic Activity, Basics:
21. List and explain the four simplifying assumptions of the Keynesian Model and explain
the implications of these assumptions.
22. Define and explain the relationship between the following terms:
a) consumption,
b) consumption goods,
c) saving,
d) disposable income,
e) investment,
f) capital goods,
g) stocks, and
h) flows.
The Keynesian Model, Consumption Function:
23. Explain what the Keynesian Consumption Function is, and they should be able graph it
on a graph with a 45-degree reference line and be able to interpret such a graph.
24. Define, distinguish between, and explain the relationship between the following
concepts related to the Keynesian Consumption Function:
a) Autonomous Consumption,
b) Average Propensity to Consume,
c) Average Propensity to Save,
d) Marginal Propensity to Consume, and
e) Marginal Propensity to Save.
The Keynesian Model, Investment Function:
25. Explain what the Keynesian Planned Investment Function is and how planned
investment is determined by the function. Students should also understand how
investment spending is included in the Keynesian 45-degree graph with consumption
spending, See Figure 12-4.
The Keynesian Model, Consumption and Investment together but excluding the
Government Sector and the Foreign Sector:
26. Explain how equilibrium is determined in a simple Keynesian model that includes only
consumption spending and investment spending in the context of the 45-degree
reference line graph and the Saving and Investment graph. In reference to both these
graphs, students should also be able to distinguish

between Planned and Actual Investment and explain how unplanned changes in
business inventories affect the national economy.
The Keynesian Model with Government and the Foreign Sector Added:
27. Explain and illustrate (using the 45-degree reference line graph) how the national
economy comes to an equilibrium when Government Spending (G) and Net Exports
(X=exports imports) are added to Consumption Spending and Investment Spending.
Students should understand in this context what it means to say that Investment
Spending, Government Spending, and Net Exports are autonomous from Real GDP.
The Keynesian Model and the Autonomous Spending Multiplier under the
assumption of a fixed Price Level (i.e., a horizontal SRAS):
28. Explain what the Multiplier Effect is and how it works in the context of Table 12-3 and
Figure C-1.
29. State the two different formulas for the multiplier (First: Multiplier = 1/(1-MPC) =
1/MPS; Second: Multiplier = (Ultimate change in equilibrium real GDP)/(change in
autonomous spending)) and be able to solve simple algebraic problems involving these
formulas.
The Keynesian Model and the Autonomous Spending Multiplier dropping the
assumption of a fixed Price Level (i.e., a horizontal SRAS) AND the Relationship
between Total Planned Expenditures (45-degree graph) and the Aggregate
Demand Curve :
30. Explain how the Multiplier works when we assume Price Level is not fixed (SRAS
slopes upward) in the context of Figure 12-7, AND the relationship between Total
Planned Expenditure (C+I+G+X) and Aggregate Demand in the context of Figure 128.

Chapter 13
After reading Chapter 13, you should be able to:
Keynesian fiscal policy:
31. Define: discretionary fiscal policy, expansionary, contractionary, policy tools.
32. Explain how Congress can use fiscal policy to close inflationary and recessionary
gaps, changing both real GDP and the price level.
33. Be able to show how fiscal policy changes appear on the AD/AS graph and determine

the appropriate policy choice.


Crowding out and the Laffer curve:
34. Explain and show graphically how crowding out reduces the effectiveness of fiscal
policy.
35. How does the Ricardian equivilence theorem explain why frequent changes in tax rates
produce very little change in consumer spending?
36. Explain and show graphically how direct expenditure offsets will reduce the
effectiveness of discretionary fiscal policy.
37. Be able to draw the Laffer curve and use it to show how supply-side economists
explain how a reduction in marginal tax rates could bring about an increase in tax
revenues.
Fiscal policy lags:
38. Define the three fiscal policy lags (recognition, action and effect) and how they
complicate using fiscal policy to 'fine-tune' the economy.
Automatic stabilizers:
39. Be able to identify the automatic stabilizers and explain how they minimize changes in
the GDP.
What Do We Really Know about Fiscal Policy?
40. When is fiscal policy most likely to be effective? Least likely? Why?

EXAM4:

Chapter 14
After reading Chapter 14, you should be able to:
1. Define the terms Government Budget Deficit, Balanced Budget, and Government
Budget Surplus.

2. Explain what the Public Debt is and to distinguish the Public Debt from the
Government Budget Deficit.
3. Discuss the history of the Government Budget Deficits and surpluses since 1940 in
terms of constant 2005 dollars and as a percentage of GDP.

4. Discuss the accumulation of the Net Public Debt in constant 2005 dollars in terms of
its absolute size since 1940.

5. Evaluate Net Public Debt in constant 2005 dollars in terms of its per capita size and as
a percentage of GDP since 1940 and to be able to discuss the size of the net interest
payments on the Public Debt as a percentage of GDP.

6. Argue whether the Public Debt is a burden on future generations or not.

7. Explain why Government Budget Deficits are related to Trade Deficits.


8. Explain several different approaches the OMB and CBO can take when measuring the
Government Budget Deficit.

9. Discuss the short and long run macroeconomic effects of budget deficits.
10. Discuss several different ways the government could reduce budget deficits.

Chapter 15
After reading Chapter 15, you should be able to:
11. Define and explain the four functions of money.
12.Indentify the key properties that any good that functions as money must
possess especially in a fiduciary monetary system.
13.Define liquidity. Explain which assets are liquid, which are not, and why not.
14.Define the transactions (M1) and liquidity (M2) approaches to defining
money making sure you know which components are in which definition.
15.Explain how financial intermediaries lower transactions costs, and define:
"direct financing," "indirect financing," "risk," "moral hazard," "asymmetric
information," "assets," and "liabilities."
16.Explain how the Fed is organized, who is included on the Board of
Governors and the Federal Open Market Committee, and the structure and
function of the district banks as well.
17.List and explain the functions of the Fed and who is responsible for each
function?
18.Explain the process through which the Federal Reserve controls the money
supply in a fractional reserve banking system.
19.Define the money multiplier and specify it in two functional forms.
20.Explain the central features of federal deposit insurance, how it can prevent
bank runs, and how its activities can affect asymentric information and moral

hazard.

Chapter 16
After reading Chapter 16, you should be able to:
The Demand for Money
21.Explain the three categories of money demand and understand how money
demand responds to changes in iterest rates and GDP and how these changes
are depicted on the money demand graph.

How the Fed Influences Interest Rates


22.Explain how the Fed's Open Market Operations influence interest rates and
hence bond prices.
Effects of an Increase in the Money Supply
23.Explain the direct and indirect effects of monetary policy on short run AD.
Include both expansionary and contractionary changes and the use of various
policy tools.
Open Economy Transmission of Monetary Policy
24.Explain how will monetary policy affect net exports and the foreign
exchange rate?
Monetary Policy and Inflation
25.Define the equation of exchange? Be able to define all four variables.
26.List the assumptions made to turn the equation of exchange into the quantity
theory of money? What does this theory predict?
Monetary Policy in Action: the Transmission Mechanism
27.Explain both expansionary and contractionary monetary policy using the

three graph transmission mechanism.

Targeting the Federal Funds Rate (and other rates)


28.Explain:
a. which three interest rates are particularly relevant to carrying out monetary
policy;
b. the role of the FOMC and the Trading Desk in carrying out monetary
policy; and
c. the role of the Taylor Rule in carrying out monetary policy.

Credit Policy at Today's Fed


29.Explain what "credit policy" is at today's Fed, how it operates, and arguments
for and against it.

Appendix E: Monetary Policy--A Keynesian Perspective


30.Understand the Keynesian approach to an increase and decrease in the
money supply and its effects on the interest rate and the GDP.

Chapter 17
After reading Chapter 17, you should be able to:
Active Versus Passive Policymaking
31.Define active and passive policymaking. Why would policy makers prefer
one or the other?
Natural Rate of Unemployment
32.Define the natural rate of unemployment, cyclical, structural, frictional.

33.Show how expansion and contractionary policy changes (either fiscal or


monetary) affect the AD-AS graph, including both short run and long run
changes.
34.Sketch a graph of the short run Phillips curve and explain its policy
implications.
35.Explain the importance of expectations as they relate to the Phillips curve
and what changes Phelps and Friedman proposed to Phillips work.
Rational Expectations and Policy Irrelevance Proposition
36.Define rational expectations and explain the short run and long run policy
implications of anticipated vs. unanticipated policy changes.
37.What is policy irrelevance, and how does it relate to rational expectations?
What is the relationship between expectations and SRAS?
Another Challenge to Policy Activism
38.Explain the real business cycle theory and supply shocks. Be able to illustrate
both harmful and beneficial supply shocks on the AD-AS graph.
Modern Approaches to Rationalizing Active Policymaking
39.Understand the Keynesian justifications for active policymaking: menu costs,
sticky prices and wages and bounded rationality.
Is There a New Keynesian Phillips Curve?
40.Explain what is meant by the New Keynesian Phillips Curve and distinguish
which beliefs about how the economy functions would lead an economist to
advocate active or passive policymaking.