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Chapter 19

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Current issues in macro theory and policy

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According to mainstream view, instability in the economy arises from two sources:

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1) price stickiness and 2) unexpected shocks to either aggregate demand or aggregate supply

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Basic equation underlying aggregate expenditures is

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C + I + X +G

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Aggregate expenditures is equal to

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GDP

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Monetarism

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1. Focuses on money supply 2. Holds that markets are highly competitive 3. says that a competitive market system gives the economy a high degree of macroeconomic stability

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The market system would provide substantial macroeconomy stability were it not for

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government interference in the economy

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Equation of exchange

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MV = PQ

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Velocity of money

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average number of times per year a dollar is spent on final goods and services

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The dollar value of total spending has to equal the

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dollar value of total output

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What does velocity is stable mean?

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Factors altering velocity change gradually and predictably and that changes in velocity from one year to the next can readily be anticipated

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Monetarist believe that ___________ is in the single most important cause of macroeconomic instability

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inappropriate monetary policy

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The inappropriate increase in the money supply leads to

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inflation

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A decrease in the money supply reduces

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aggregate demand

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Mainstream economist view the instability of ___________ as the main cause of the economy's instability

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investment

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Monetarists view changes in the ___________ as the main cause of instability in the economy

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money supply

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Real business cycle theory

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business fluctuations result from significant changes in technology and resource availability. Those changes affect productivity and thus the long-run growth trend of aggregate supply

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A large increase in aggregate supply cause by major innovations in the production process would

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shift the aggregate supply curve rightward

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In the real business cycle theory, macro instability arises on the ________ of the economy, not on the ________ side as mainstream economist and monetarist usually claim

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aggregate supply; aggregate demand

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Coordination failures

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failures occur when people fail to reach a mutually beneficial equilibrium because they lack a way to coordinate their actions

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In the real business cycle theory, significant changes in "real" factors such as technology, resources availability, and productivity change the economy's ___________, causing macroeconomic availability

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long-run aggregate supply

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Rational expectations theory

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the idea that businesses, consumers, and workers expect changes in policies or circumstances to have certain effects on the economy and, in pursuing their own self interest, take actions to make sure those changes affect them as little as possible

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New classical economics

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holds that when the economy occasionally diverges from its full-employment output, internal mechanisms within the economy will automatically move it back to the output

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Adaptive expectations

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Monetarists view that people form their expectations on the basis of present realities and only gradually change their expectations as experience unfolds

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Other new classical economists accept the rational expectations assumption that workers anticipate

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some future outcomes before they occur

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The implication of RET is not only that the economy is self correcting but that self correction occurs

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quickly

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Price level surprises

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un-anticipated changes in the price level that do cause temporary changes in real output

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A full anticipated price level decrease will leave real output

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unchanged

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Efficiency wage

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is a wage that minimizes the firm's labor cost per unit of output

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Paying a wage that is higher than the market wage will lower their

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wage cost per unit of output

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How can a higher wage result in greater efficiency?

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1. Greater work effort 2. Lower supervision costs 3. Reduced job turnover

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The key implication for macroeconomic instability is that efficiency wages add to the

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downward inflexibility of wages

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Insider-outside theory

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outsiders may not be able to underbid existing wages because employers may view the non wage cost of hiring them to be prohibitive

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New economists believe that the economy "self corrects" when

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unanticipated events divert it from its full employment level of real output

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Sources of downward wage inflexibility include

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contracts, efficiency wages, and insider outsider relationships

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Monetarist and other new classical economist believe policy rules

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would reduce instability in the economy

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Monetary rule

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would require the Fed expand the money supply each year at the same annual rate as the typical growth of the economy's production capacity

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Inflation targeting

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under which the Fed would be required to announce a targeted band of inflation rates, say 1 to 2, percent for some future period such as the following 2 years. It would then be expected to use its monetary policy tools to keep inflation rates within that range

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Taylor rule

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rule specifies how the Fed should alter the Federal funds rate under differing economic circumstances

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Mainstream economists oppose both a

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strict monetary rule and a balanced budget requirement

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Mainstream economists support the use of ____________ to keep recessions from deepening or to keep mild inflation from becoming severe inflation

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fiscal policy

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Chapter 20

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International Trade

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Trade deficit

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occurs when imports exceed exports

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Trade surplus

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occurs when exports exceed import

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Principal U.S. exports include

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chemicals, agricultural products, consumers durable, semiconductors, and aircraft

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Principal U.S. imports include

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petroleum, automobiles, metals, household appliances, and computers

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Labor intensive goods

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such as textiles, electronics, apparel, toys, and sporting goods

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Land intensive goods

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as beef, wool and meat

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Capital intensive goods

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as airplanes, automobiles, agricultural equipment machinery and chemicals

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In an open economy a country produces

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more of certain goods (exports) and fewer of other goods (imports)

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Absolute advantage

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if it is the most efficient producer of the product (by which we mean that it can produce more output of that product from an given amount of resource inputs that can any other producer)

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Comparative advantage

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if it can produce the product at a lower opportunity cost (by which we mean that it must forgo less output of alternative products when allocating productive resources to producing the product in question)

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Adam Smith used absolute advantage to make his point that

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nations would be better off if they specialized in the production of those products in which they had an absolute advantage and were the most efficient producers

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A producer has a comparative advantage in producing a particular product

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if it can produce that produce at a lower opportunity cost than other producers

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Principle of comparative advantage

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which says that total output will be greatest when each good is produced by the nation that has the lowest domestic opportunity cost for producing that good

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Terms of trade

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the exchange ration at which the United States and Mexico trade beef and vegetables

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Terms of trade determines

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whether each country can "get a better deal" by specializing and trading than it could if it opted instead for self sufficiency

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Actual exchange ratio

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is set by world supply and demand determines how the gains from international specialization and trade are divided between the two nations and consequently, how the beef that is all produced in the United States and the vegetables that are all produced in Mexico get divided among consumers in the two countries

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Trading possibility line

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show the amounts of the two products that a nation can obtain by specializing in one product and trading for the other

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Specialization results in

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a more efficient allocation of world resources, and larger outputs of both products are therefore available to both nations

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An economy can grow by

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expanding international trade

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Government trade barriers

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Lessen or eliminate gains from specialization. If nations cannot trade feely, they must shift resources from efficient to inefficient uses to satisfy their diverse wants

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Benefit of free trade

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is that it promotes competition and deters monopoly. It also compels them to be innovative with respect to both product quality and production method, thereby contributing to economic growth

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Specialization is less than complete among nations because

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opportunity costs normally rise as an specific nation produces more of a particular good

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World price

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the interaction of word supply and demand determines the equilibrium. This price equates the quantities demanded and supplied globally

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Domestic price

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the price that would prevail in a closed economy that does not engage in international trade

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Export supply curve

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found by connection points a,b, and c. This curve slopes upward indicating a direct or positive relationship between the world price and the amount of U.S exports

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Import demand curve

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this downsloping curve shows the amounts of aluminum that will be imported at a world price below the $1 U.S domestic price.

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The relationship between world prices and imported amounts is

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inverse or negative

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Equilibrium world price

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the equilibrium world levels of exports and imports when the world is opened to trade

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International equilibrium occurs

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where one nations import demand curve intersects another nations export supply curve

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A nation will export a particular product if the

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world price exceeds the domestic price

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Tariffs

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are excise taxes or "duties" on the dollar values or physical quantities of imported goods

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Revenue tariff

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is usually applied to a product that is not being produced domestically for example, tine, coffee, or bananas in the case of the United States

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Protective tariff

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is implemented to shield domestic producers from foreign competition. These tariffs impede free trade by increasing the prices of imported goods and therefore shifting sales toward domestic producers

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Import quota

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is a limit on the quantities or total values of specific items that are imported in some period

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Nontariff barrier

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includes onerous licensing requirements, unreasonable standards pertaining to product quality, or simply bureaucratic hurdles and delays in customs procedures

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Voluntary export restriction

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is a trade barrier by which foreign firms "voluntarily" limit the amount of their exports to a particular country

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Export subsidy

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consists of a government payment to a domestic producer of export goods and is designed to aid that producer.

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By reducing production costs, the subsidies enable domestic firms to

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charge a lower price and thus to sell more exports in world markets

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Tariffs directly promote the expansion of inefficient industries that

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do not have a competitive advantage

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Dumping

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is the sale of a product in a foreign country at prices either below cost or below the prices commonly charged at home

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Dumping that involves selling abroad at a price that is below the price commonly charge in the home country is a form of

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price discrimination

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Fallacy of composition

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the false idea that what is true for the part is necessarily true for the whole- is also present in this rationale for tariffs

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Nations adversely affected by tariffs and quotas are likely to retaliate causing a

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trade war, that will choke off trade and make all nations worse off

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Smoot Hawley Tariff Act

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meant to reduce imports and stimulate U.S production, the high tariffs it authorized prompted adversely affected nations to retaliate with tariffs equally high ^contributed to the great depression

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General Agreement on Tariffs and Trade

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GATT was based on three principles: 1) equal, nondiscriminatory trade treatment for all member nations; 2) the reduction of tariffs by multilateral negotiation; and 3) the elimination of import quotas

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World Trade Oeganization

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Oversees trade agreements reached by the member nations, and rules on trade disputes among them. GATTs successor

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Doha development agenda

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the negotiations are aimed at further reducing tariffs and quotas, as well as agricultural subsidies that distort trade

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European Union

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comprised of 27 nations

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North American Free Trade Agreement

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established a free trade area that has about the same combined output as the EU but encompasses a much larger geographic area

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Trade Adjustment Assistance Act

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introduced some innovative policies to help those hurt by shifts in international trade patterns

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Offshoring

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shifting work previously done by American workers to workers located in other nations

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Two types of international financial transactions

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international trade and international asset transactions

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What are the two only things individuals and firms can exchange with each other

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currently produced goods and services or preexisting assets

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Two basic types of transactions

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people trading either goods or services for money and people trading assets for money

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What do they have to do when people involved in an exchange are from different place with different currencies?

answer

The buyer must convert their own currencies into the currencies that the sellers use and accept

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balance of payments

answer

is the sum of all the financial transactions that take place between its residents and the residents of foreign nations

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What items are included in the balance of payments?

answer

exports and imports of goods, exports and imports of services, and international purchases and sales of financial and real assets and also tourist expenditures, interest and dividends received or paid abroad, debt forgiveness, and remittances made by immigrants to their relatives back home

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Current amount

answer

mainly summarizes U.S trade in currently produced goods and services U.S exports have a plus (+) sign because its a credit U.S imports have a minus (-) sign because they are a debit

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The differences between what equals a balance of trade?

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the difference between exports and imports

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Balance of goods

answer

is the difference between U.S exports of goods and services and U.S imports of goods and services

Macroeconomics Final Chapters 19-21 – Flashcards

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