1. Which of the following equations is correct?
A. Real exchange rate = (exchange rate + domestic price level) / foreign price level
B. Exchange rate = (real exchange rate × domestic price level) / foreign price level
C. Real exchange rate = (nominal exchange rate × domestic price level) × foreign price level
D. Real exchange rate = (nominal exchange rate × domestic price level) / foreign price level
2. The difference between exports and imports in determining the GDP is known as the:
a) Net exports
b) Import tariffs.
c) Net imports.
d) Net income
3. Unemployment that naturally occurs during the normal workings of an economy as people change jobs and move across the country is called
A. Structural unemployment.
B. Frictional unemployment.
C. Natural unemployment.
D. Cyclical unemployment.
4. The demand for labor curve shows:
A. An inverse relationship between the real wage and the number of workers who are willing to work.
That real wages are constant.
That real wages are constant.
B. An inverse relationship between the real wage and the amount of labor hired.
A positive relationship
A positive relationship
5. Which of the following statements about net exports is correct?
A. The term C + I + G understate domestic production of goods and services because it leaves out exports, which must be subtracted out of GDP to obtain the correct figure.
B. The term C + I + G overstates domestic production of goods and services because it contains imports, which must be subtracted out of GDP to obtain the correct figure.
C. The difference between exports and imports is negative when the country is a net exporter.
Before 1976,
Before 1976,
6. Which of the following equations is correct?
A. Nominal interest rate = real interest rate – inflation
B. Real interest rate = nominal interest rate + inflation
C. Real interest rate = nominal interest rate × inflation
D. Real interest rate = nominal
7. If the U.S. real exchange rate increases, then U.S. ------------------ will fall and U.S.
A. Imports; exports
B. Income; imports
C. Exports; income
D. Exports; imports
8. Which one of the following could explain a shift to the right of the supply curve for a good?
- The imposition of a tax on the good
- A new supplier entering the market
- A rise in firms’ wage costs
- A rise in the price of the good
9. Which of the following is NOT included in M1?
A. Deposits in checking accounts
B. Deposits in checking accounts that pay interest
C. Currency held by the public
D. None of the given options
10. The circular flow is used to make the point that:
A. Households are both earners and spenders.
B. Production generates income.
C. Unemployment only occurs during a recession.
D. Rising prices never occur during times of unemployment
11. Currency held by the public is included in:
- Neither M1 nor M2.
- M2 only.
- M1 only.
- Both M1
12. If Umar does not have a job and is not currently looking for work but has looked in the past, he is considered:
- Not in the labor force.
- Unemployed and in the labor force.
- Unemployed.
- Unemployed and not in the labor force.
13. An asset that is included in M3 but not in M2 is:
- Currency.
- Checkable deposits.
- Small-denomination certificates of deposit.
- Large-denomination
15. Is the narrowest definition of the money supply?
A. Includes the most liquid forms of money.
B. Includes travelers' checks.
C. All of the given options
D. M!
E. M1
INLFATION RATE
As there are so many domestic investors which will invest in the market because their concern is with profit and company is purchasing all the equipments from domestic area so competition will increase then inflation rate will get decrease so purchasing power of people will increase.
TAX RATE;
AS production will increase then tax on things will also increase.so tax rate will also increase.
CPI:
This action of nonprofit organization will change the economic growth , price of goods will change so consumer spending pattern will also change. Competition will be high so price will decrease of goods and then consumer will spend more
UNEMPLOYMENT:
It will decrease the unemployment as, it will change the business cycle because consumer expectations can indicate future consumer spending. As unemployment will decrease then well being of society will increase.
INTEREST RATE:
As the company is purchasing all equipments from domestic market so investors will invest more because it is nonprofit organization and investor’s concern is just with return, this thing will attract them more to invest.
show the relationship b/w net foreign investment and t
Sub C&G from both sides we get Y-C-G=I+NX As Y-C-G=NATIONAL SAVINGS WE SAY IT AS "S" now we have S=I+NX Subtract I from both sides we get S-I=NX This is the form of national account identity also it shows that the net export must always equal to the difference b/w its savings and its investmentrade balance using Y=C+I+G+NX
Hyperinflation is double digit inflation. It is the extreme form of inflation. Hyperinflation is when the prices of commodities and services skyrocket, usually more than or equal to 50% a month
THE CLASSICAL THEORY OF INFLATION
INFLATION
In economics, inflation is a rise in the general level of prices of goods and services in an
economy over a period of time. The term "inflation" is also defined as the increases in the
money supply (monetary inflation) which causes increases in the price level.
.
The basic measure of price inflation is the inflation rate, which is the percentage change in a price index over time.
· “Classical” -- assumes prices are flexible & markets clear.
· This applies to the long run.
MONEY
Money is the stock of assets that can be readily used to make transactions.
MONEY: FUNCTIONS
· Medium of exchange: we use it to buy stuff.
· Unit of account: the common unit by which everyone measures prices and values.
· Store of value: transfers purchasing power from the present to the future.
LIQUIDITY
The ease with which money is converted into other things-- goods and services-- is sometimes
called money’s liquidity.
MONEY: TYPES
· Fiat money: has no intrinsic value, example: the paper currency we use.
· Commodity money: has intrinsic value, examples: gold coins.
The money supply is the quantity of money available in the economy. Monetary policy is the
control over the money supply.
Monetary policy is generally referred to as either being an expansionary
policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply.
State Bank controls the money supply in three ways.
· Open Market Operations (buying and selling Treasury bills).
· Δ Reserve requirements.
· Δ Discount rate which commercial banks pay to borrow from the State Bank.
SYMBOL ASSETS INCLUDED
CCurrency
M1 C + demand deposits, travelers’ checks, other checkable deposits
M2M1 small time deposits, savings deposits, money market mutual funds,
money market deposit accounts
M3 M2 + large time deposits, repurchase agreements, institutional money
Market mutual fund balances
SEIGNIORAGE
To spend more without raising taxes or selling bonds, the govt. can print money. The
“revenue” raised from printing money is called seigniorage
(pronounced SEEN-your-age).
The inflation tax:
Printing money to raise revenue causes inflation. Inflation is like a tax on people who hold
money.
INFLATION AND INTEREST RATES
Nominal interest rate, i is not adjusted for inflation. Real interest rate, r is adjusted for inflation:
r = i- p
THE FISHER EFFECT
The Fisher equation: i = r + p
S = I determines r. Hence, an increase in p causes an equal increase in i. This one-for-one
relationship is called the Fisher effect.
TWO REAL INTEREST RATES
p = actual inflation rate (not known until after it has occurred).
pe = expected inflation rate
· i – pe = ex ante real interest rate: what people expect at the time they buy a bond or
take out a loan
· i – p = ex post real interest rate: what people actually end up earning on their bond or
paying on their loan
ADDITIONAL COST OF UNEXPECTED INFLATION:
Arbitrary redistributions of purchasing power. Many long-term contracts not indexed, but based
onpe. If p turns out different from pe, then some gain at others’ expense.
For example, borrowers & lenders, If p >pe, then (r-p) < (r-pe)
then purchasing power is transferred from lenders to borrowers. If p <pe, then purchasing
power is transferred from borrowers to lenders.
ONE BENEFIT OF INFLATION
Nominal wages are rarely reduced, even when the equilibrium real wage falls. Inflation allows
the real wages to reach equilibrium levels without nominal wage cuts. Therefore, moderate
inflation improves the functioning of labor markets.
WHAT CAUSES HYPERINFLATION?
Hyperinflation is caused by excessive money supply growth. When the central bank prints
money, the price level rises. If it prints money rapidly enough, the result is hyperinflation.
Real variables are measured in physical units: quantities and relative prices, e.g. Quantity of
output produced, real wage: output earned per hour of work, real interest rate: output earned
in the future by lending one unit of output today
Nominal variables are measured in money units: e.g. nominal wage: dollars per hour of
work, nominal interest rate, dollars earned in future
by lending one dollar today,
INTERNATIONAL CAPITAL FLOWS
Net capital outflows
=S – I =net outflow of “loanable funds” =net purchases of foreign assets
Net capital outflows
The country’s purchases of foreign assets minus foreign purchases of domestic assets. When
S > I, country is a net lender, when S < I, country is a net borrower. An open-economy version
of the loanable funds model includes many of the same elements.
SAVING AND INVESTMENT IN A SMALL OPEN ECONOMY
NATIONAL SAVING: THE SUPPLY OF LOANABLE FUNDS
ASSUMPTIONS: CAPITAL FLOWS
· Domestic & foreign bonds are perfect substitutes.
· Perfect capital mobility: no restrictions on international trade in assets,
· Economy is small: cannot affect the world interest rate, denoted r*.
= C + I + G + E X - ( Cf + I f + G f )
= C + I + G + E X - I M
= C + I + G + N X
production function: Y =Y= F (K ,L)
consumption function: C = C (Y -T )
investment function:I = I (r )
exogenous policy variables: G = G , T =T
ASSUMPTIONS: CAPITAL FLOWS
· Domestic & foreign bonds are perfect substitutes.
· Perfect capital mobility: no restrictions on international trade in assets,
· Economy is small: cannot affect the world interest rate, denoted r*.
Nominal exchange Rate:
THE nominal exchange rate is simply the price of one currency in terms of the number of units of some other currency. The nominal exchange rate E is defined as the number of units of the domestic currency that can purchase a unit of a given foreign currency.
Formula:
The nominal exchange rate e is the price in domestic currency of one unit of aforeign currency.
where P* is the foreign price.
e = EP*/P.
Real Exchange Rate:
The relative price of domestic goods in terms of foreign goods.
the ratio of the price level abroad and the domestic price level, where the foreign price level is converted into domestic currency units via the current nominal exchange rate
Formula:
effective price of domestic goods for foreigners is eP, where P is the domestic price and e is the nominal exchange rate. So
E = eP/P*
FISCAL POLICY AT HOMEA fiscal expansion reduces national saving, net capital outflows, and the supply of dollars in the foreign exchange market causing the real exchange rate to rise and NX to fall.
FISCAL POLICY ABROAD
An increase in r* reduces investment increasing net capital outflows and the supply of dollars
in the foreign exchange market causing the real exchange rate to fall and NX to rise.
An increase in investment reduces net capital outflows and the supply of dollars in the foreign
exchange market causing the real exchange rate to rise and NX to fall.
DOES PPP HOLD IN THE REAL WORLD?
PPP does not hold in the real world for two reasons:
1. International arbitrage not possible.
· Non traded goods
· Transportation costs
2. Goods of different countries not perfect substitutes.
Nonetheless, PPP is a useful theory:
· It’s simple & intuitive
· In the real world, nominal exchange rates have a tendency toward their PPP values
over the long run.
PURCHASING POWER PARITY (PPP)
A doctrine that states that goods must sell at the same (currency-adjusted) price in all
countries is known as PPP. In PPP, the nominal exchange rate adjusts to equalize the cost of
a basket of goods across countries. The reason for PPP is arbitrage, the law of one price.
PPP: e x P = P*
ISSUES IN UNEMPLOYMENT
NATURAL RATE OF UNEMPLOYMENT
Natural rate of unemployment is the average rate of unemployment around which the
economy fluctuates. In a recession, the actual unemployment rate rises above the natural rate.
In a boom, the actual unemployment rate falls below the natural rate.
NATURAL RATE OF UNEMPLOYMENT
Natural rate of unemployment is the average rate of unemployment around which the
economy fluctuates. In a recession, the actual unemployment rate rises above the natural rate.
In a boom, the actual unemployment rate falls below the natural rate.
BREAK-EVEN INVESTMENT
(d + n) k = break-even investment, the amount of investment necessary to keep k constant.
· Break-even investment includes:
· dk to replace capital as it wears out.
· nk to equip new workers with capital. (Otherwise, k would fall as the existing capital
stock would be spread more thinly over a larger population of workers).
THE EQUATION OF MOTION FOR k
With population growth, the equation of motion for k is Dk = s f (k) - (d + n) k. Where S f (k)
= actual investment, (d + n) k = breakeven investment.
STARTING WITH TOO MUCH CAPITAL
Then increasing c* requires a fall in s. In the transition to the Golden Rule, consumption is
higher at all points in time.
STARTING WITH TOO LITTLE CAPITAL
Then increasing c* requires an increase in s. Future generations enjoy higher consumption,
but the current one experiences an initial drop in consumption.
THE GOLDEN RULE LEVEL OF CAPITAL STOCK
K*gold = the Golden Rule level of capital, the steady state value of k that maximizes
consumption. To find it, first express c* in terms of k*:
c* = y* - i*
= f (k*) - i*
= f (k*) - k*
In general: i= Dk + k, in the steady state: i* = k* because Dk
What happen to export & import, if exchange rate change in domestic country:
If real exchange rate increase then
↑ε ⇒US goods become more expensive relative to foreign goods ⇒ ↓EX, ↑IM⇒ ↓NX
Export of domestic country decrease and Import Increase :
A higher currency makes a country's exports more expensive and imports cheaper.
If real exchange rate decreasthen :
increase exports and decrease imports:
A lower exchange rate would increase Export and decrease imports :
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