question

What is opportunity cost and why is there no free lunch?

answer

Opportunity Cost = Missing out on doing the "next best thing" by choosing to do something else that is "better" There is no free lunch because nothing is ever free. There is an opportunity cost to everything.

question

What does the invisible hand mean, and why does it suggest laissez-faire?

answer

Coined by Adam Smith It means that people maximize self-interest and the market is guided by their self-interest. This leads to regulations not being needed --> Laissez-Faire.

question

What is the definition of Microeconomics? Macroeconomics? Economics?

answer

Micro - What? How? Who? Behaviors of entities and the role of prices & markets Macro - SR vs LR. The overall level of output (GDP), overall level of prices, economic growth, and role of monetary & fiscal policies Economics - Study of scarcity and tool of science to be applied to social issues

question

What is the relation between Gross and Net Investment and Depreciation

answer

Gross Investment does not account for depreciation and is NOT a good indicator of economic growth, while Net Investment is.

question

Definition of Real and Nominal GDP

answer

Real GDP calculates GDP by comparing to a base year, accounting for inflation. Nominal GDP calculates GDP by using the price of that year to evaluate economic productivity of that current year.

question

How do you calculate real GDP from nominal?

answer

Real GDP = Nominal GDP/(GDP Deflator/100)

question

How do we measure/calculate Unemployment, Labor Force, Employment

answer

Surveys. If yes, they are employed. If no, ask if they are seeking a job. If yes to that, they are unemployed. If no, they are not a part of the labor force. Unemployment Rate = (Unemployment/Labor Force) Labor Force = Unemployed + Employed

question

What is the CPI? What is it used for?

answer

Consumer Price Index. Used to show changes in prices of goods/services. Also shows inflation, which tends to be overestimated.

question

What are some shortcomings of GDP as measure of economic activity and wellbeing?

answer

GDP does not account for household productions, leisure, and illegal activities (under-the-table transactions).

question

What are stocks?

answer

Stocks = equity They are shares of a given company Stock Price = (Dividends/Risk Adjusted Discount Rate)

question

What is leverage, liquidity, buying on margin, selling short?

answer

Leverage = Increasing risk and profit by mixing loans and your own money into an investment Liquidity = The access/availability of a liquid asset (cash) to someone or a company. ex.) Asset 1 is very liquid, meaning it can be converted to cash very easily. Buying on Margin = Borrowing money from a broker to buy more shares than you can afford Selling Short = Borrowing a broker's shares to sell (short) and then buying back (covering) to pay back the broker in hopes to keep the difference made. Very risky.

question

What is a speculative bubble?

answer

Rapid increase in price of an asset not justified by economic fundamentals. If the bubble bursts, there will be a sharp fall in value.

question

How does stock compare to bonds as an investment?

answer

Stocks are riskier and have higher returns Bonds are safer and have lower returns

question

How and why should you invest in stocks?

answer

Buy and hold for the LR Stocks yield the highest returns than other financial assets

question

What is the advantage of diversification?

answer

Reduces risk with same return

question

What is the efficient markets hypothesis, and how does it relate to random walks?

answer

Efficient market hypothesis = information is rapidly incorporated into the price of a security --> the price reflects the value. Only new information will change the prices of the securities. Random Walks = prices change unpredictably. No one should try to beat the market. Buy the market instead --> index mutual funds

question

What are Mutual Funds?

answer

A portfolio of diversified stocks and bonds

question

What is a stock index mutual fund, and why should you likely use it for long-run investing?

answer

A portfolio of stocks that reflect the index you are investing in. Ex.) A stock index mutual fund of the NASDAQ will buy stocks of the NASDAQ to reflect the growth of that particular index. You should by it in the LR because it will most likely go up consistently.

question

What is Money? Wealth? Income? How are they different?

answer

Money = It is a medium of exchange (universally accepted). It is also a store of value and a unit of account (Item holds value over time and a consistent means of measuring value) Wealth = The amount of days you are able to survive and the possessions you have Income = Flow of Money

question

Define M1. Roughly, what's in M2 that is not in M1?

answer

M1 = Used in transactions --> currency in circulation, checkable deposits, and traveler's checks M2 = M1 + other deposits and money market mutual funds

question

What are the three functions of money?

answer

- Medium of exchange (universally accepted as a form of payment) - Store of value (holds value over time) - Unit of account (consistent means of measuring value of an item)

question

What are the advantages of an economy using money rather than barter?

answer

Less steps; cuts out "the middle man" Everyone wants money whereas, not everyone wants what you are willing to trade

question

What is barter and what are the shortcomings of barter?

answer

Barter = trading commodities to get what you want. Ex.) Trading blankets for wood Shortcomings = people don't always want what you're willing to give

question

What is the Fed? Describe its structure. Why does the Fed have the structure it does (12 banks, etc). What is the FOMC?

answer

Fed = Central bank; the banker to all banks. - Regulates banks - Controls Ms through monetary policies - Supports stability of the financial system - Independent of Congress FOMC (Federal Open Market Committee) - Has 12 banks and 7 members on the Board of Directors to destabilize power

question

Explain in words how a Fed open market purchase increases the money supply

answer

Feds buy bonds, increasing Ms. Bank lends out some of the reserves, increasing M1, increasing Ms.

question

What is the central operating target of the Fed?

answer

fed funds rate

question

What is the primary 'traditional' policy tool of the Fed?

answer

Open market operations --> the buying and selling of bonds, dictating Ms.

question

What are the ultimate goals of the Fed?

answer

Dual Mandate - Price Stability -Maximum employment - (also moderate LR interest rate) All through LR economic growth

question

What is the Taylor Rule?

answer

If inflation and employment rates are too high, increase the interest rate ( i ). Higher interest rate --> Decrease in Ms --> Lower inflation rate --> higher unemployment

question

What is the liquidity trap and why does it matter?

answer

Liquidity trap is when the interest rate cannot go any lower (maybe because it's already at 0). Ms has no affect on decreasing interest rate at this point

question

Is the Fed Independent?

answer

Yes. It is in order to spread the power rather than having the government have so much power

question

What is quantitative easing? How did/does it work?

answer

Banks convincing the public that it will keep interest rates low to avoid deflation. It works if the banks are trusted and have a good reputation.

question

What is unconventional monetary policy?

answer

Quantitative easing and forward guidance

question

Why is Fed credibility important?

answer

Shapes the expectations of inflation in the future which greatly influences the actual inflation rate that transpires

question

What determines aggregate prices and output?

answer

AS & AD

question

What determines interest rates?

answer

Ms (inversely related)

question

What are the components of aggregate demand?

answer

AD = C + I + G + NX C is affected by disposable income (Y-T) I is affected by interest rates ( i ) and Ms G is affected by fiscal policies NX is affected by exports - imports (X-M)

question

What are the key determinants of Consumption? Saving? Investment? Government Expenditures? Exports? Imports?

answer

- C is affected by disposable income (Y-T) - I is affected by interest rates ( i ) and Ms - S is affected by output - consumption (Y-C) - G is affected by fiscal policies - NX is affected by exports - imports (X-M) - Exports and Imports affected by inflation and deflation which depreciates/appreciates the value of the dollar

question

How does the stock market affect the economy?

answer

Wealth Effect --> Makes people think they have more/less money than what they really do causing them to spend more/less than what they should be doing

question

What are the 'types' of unemployment?

answer

- Frictional (time taken to switch jobs) - Structural (lacking the skills/education) - Cyclical (variation in unemployment due to economic movement...excess unemployment past the Natural Rate) - Natural Rate (equilibrium)

question

What is inflation and what causes it in the short-run?

answer

Inflation = the general increase in prices of goods/services It's caused by an increase in Ms (monetary policies)

question

What is the short-run Phillips curve and why is it important?

answer

It shows inflation and unemployment being inversely related. It's important as it show what monetary policies to follow as Ms affects inflation which affects unemployment.

question

What causes business cycles, and what are they?

answer

- Changes in demand - Bad monetary policies - New technology - Demand and supply shocks/pushes They are reoccurring, but irregular ups & downs in economic activity

question

How does monetary policy impact the economy in the short-run?

answer

Monetary policy affects Ms. Ms up -> i down -> I up -> D up -> P, Y up Ms down -> i up -> I down -> D down -> P, Y down

question

How does fiscal policy impact the economy?

answer

G up -> D up -> P, Y up & vice versa

question

What is the impact of a government budget deficit in the SR?

answer

Gov budget deficit = Expenditures > Revenue, thus forcing the Gov to sell bonds. Selling bonds -> Ms down -> deflation -> dollar appreciates -> more imports, less exports -> D down Selling bonds also causes interest rates to go up and Investment down

question

What is the paradox of thrift?

answer

People tend to save more in a recession, causing less income, causing less total savings (spiral effect). S up -> C down -> AD down -> Y down -> S down

question

What is the wealth effect?

answer

When people think they have more money than what they really do due to the stock market, causing them to spend more

question

What is the effect of an increase in saving in the short run?

answer

S up -> C down -> AD down -> Y down -> S down

question

What is the effect of an increase in investment in the short-run?

answer

I up -> D up -> Y up

question

What determines output?

answer

Capital, Labor, & Technology (K, L, tech)

question

What determines prices?

answer

Ms (Quantity Theory --> Ms*V=P*Y where V is constant --> Ms=P*Y)

question

What determines interest rates?

answer

LR: Savings & Investments (S, I) = interest rate Loanable Funds Theory And Ms SR: Supply and Demand shocks

question

What is loanable funds theory?

answer

Savings and Investments determines LR interest rate Desired S=I

question

What is Say's law?

answer

Supply creates demand

question

What is the quantity theory?

answer

Ms*V=P*Y where V is constant

question

What is the natural rate of unemployment (NAIRU)?

answer

- Lowest rate of unemployment in the LR - Inflation is at 0 and is constant - Structural and frictional unemployment only - LR Phillips curve is vertical at NAIRU

question

What is the relation between the nominal and real interest rates and inflation?

answer

Fisher's Equation Real Interest Rate = Nominal Interest Rate - Inflation

question

What causes inflation in the long-run?

answer

Rapid Ms growth

question

What role does saving play in the long-run?

answer

allows for increased investment

question

What role does investment play in the long-run?

answer

Increases economic growth

question

What causes unemployment in the long-run?

answer

Natural Rate of Unemployment - Frictional - Structural

question

What is crowding out?

answer

When fiscal policies have no effect in the LR When G up -> i up -> I down -> crowding out

question

How does fiscal policy affect the economy in the long-run?

answer

It doesn't. It is crowded-out

question

How does monetary policy affect the economy in the long-run?

answer

It only affects price

question

What is the long-run Phillips curve and what does it imply? What makes the short-run curve shift to the right?

answer

- LR Phillip's Curve is vertical - This implies that inflation and unemployment and inflation are independent of each other - SR curve only increases with an increase in labor force

question

What role do inflationary expectations play in inflation and the Phillips curve?

answer

Expectations in inflation causes the expectations to come true. Ex.) Expecting an increase in inflation will increase inflation, causing less unemployment to occur in SR, but has no affect on unemployment in LR

question

What is the long-run average rate of growth in U.S. real GDP? Real GDP per capita?

answer

3% for US Real GDP Growth Rate 2% for Real GDP per capita

question

What is productivity? Why does it matter to economic growth?

answer

- Productivity = Output per worker (Y/L) - Real GDP = Productivity*Labor Y = (Y/L)*L

question

What is the role of technology in economic growth?

answer

Technology helps economic growth as it increases productivity leading to an increase in GDP

question

What is the rule of 72? (Or 70)? How do you use it?

answer

Number of years to double = (72/Growth Rate)

question

How does an increase in saving affect the economy in the long run? (short-run?)

answer

LR = S up -> I up -> Productivity up -> Economy up SR = S up -> C down -> D down -> Y down -> Economy down

question

Creative Destruction

answer

Something new replacing something old (Schumpeter)

question

What's wrong with Malthus' law?

answer

Population grows geometrically while food grows arithmetically (Population grows too fast) It ignores increases in capital, technology changes, and population control

question

What is capital? Human capital

answer

Capital = wealth in form of money & assets Human capital = the value of skills, knowledge, and intelligence an individual possesses

question

What role does capital play in the macroeconomics in the SR? LR?

answer

SR = More capital allows for an increased in Investment = higher AD -> P, Y up LR = More capital leads to higher productivity -> economic growth

question

What affects the present value of a future amount?

answer

interest rate and amount of years away from the future amount PV = (FV/[(1+i)^n])

question

How does an increase in capital affect labor?

answer

Reduces employment in an industry as it increases marginal product of labor

question

Define inflation

answer

The general increase in prices which depreciates the value of a given currency

question

How do we measure inflation?

answer

Using CPI (consumer price index)

question

What can cause inflation in the short-run?

answer

Demand and supply shocks

question

What can cause inflation in the long-run?

answer

Increase in Ms

question

What harm does anticipated inflation cause?

answer

Menu and shoe leather cost Menu cost = The cost it takes to constantly change prices Shoe leather cost = The time and effort to counteract inflation

question

What harm does unanticipated inflation cause?

answer

- Causes wealth to transfer from lenders to borrows & distorts the price system - Can also cause increases in taxes while real income doesn't change

question

What is deflation and what harm does it cause?

answer

A general decline in prices of goods/services, causing a given currency to appreciate. This is bad because a strong currency increases imports, but decreases exports. When M>X, there becomes a current account deficit/financial account surplus, which is bad.

question

Which is considered more dangerous, inflation or deflation?

answer

Both inflation and deflation can be bad - Hyperinflation can cause a loss in confidence in a currency as it's worthless (ex. Zimbabwe) - Extreme deflation can cause a depression -> not enough demand My opinion) Deflation is worse because at least you can recover from hyperinflation whereas in an extreme form of deflation, you can't.

question

What's the short-run Phillip's curve? What policy does it imply?

answer

Inflation and Unemployment are inversely related It implies Monetary policies as Ms controls inflation which controls the unemployment rate

question

What's the long-run Phillip's curve? What's the implication of the slope of the long-run Phillip's curve.

answer

It is vertical. It implies that inflation and unemployment are independent of each other. Only an increase in the labor force can shift the curve.

question

What's the relation between Fed credibility and inflation? Between inflation expectations and inflation? Between unemployment and inflation?

answer

- More Fed credibility -> I up -> inflation down - Inflation expectations causes the expected inflation rate to occur - Unemployment and inflation are inversely related

question

What does it take to be counted as unemployed?

answer

Not employed and actively seeking for a job

question

How do we define the unemployment rate? The Labor Force participation rate?

answer

Unemployment Rate = (Unemployed/Labor Force) - Labor Force = Unemployed + Employed Labor Force participation rate = (Labor Force/Population)

question

Define the natural rate of unemployment (NAIRU). Why does it matter?

answer

NAIRU = lowest rate of unemployment in LR because inflation is constant & at 0

question

What's the relation between wages, prices and productivity?

answer

W/P=MP or W=PxMP and %change W = % change P + % change MP

question

According to marginal productivity theory, what is a key determinant of the real wage?

answer

Real Wage = W/P in LR

question

What are some benefits of international trade? Some of its harms?

answer

Benefits = Competition, transmission of ideas, comparative advantage, & economies of scale Disadvantages = If imports > exports -> possible current account deficit/financial account surplus may happen

question

What is the basic idea of comparative advantage?

answer

Countries specializing in producing goods/services they are best at (lowest opportunity cost) and trading it to get the rest of what they want. Both countries will get more of both goods/services as opposed to doing it themselves. Ex.) US is good at producing steel and China is good at producing silk. They maximize production and trade for the other country's goods. Now, both countries have the most of both goods they can possibly have.

question

How do exports and imports affect the macroeconomics?

answer

Export > Import -> Current account surplus/financial account deficit = good Exports Current account deficit/financial account surplus = bad -> selling of bonds occur -> Ms down -> i up -> I down -> D down -> Output down

question

What impact does an open economy have on the effectiveness of monetary policy? On fiscal policy?

answer

Monetary Policy -> strengthens economy Ms up -> i down -> Value of dollar depreciates -> X up & M down -> D up -> stronger economy Fiscal Policy -> weakens economy G up -> i up -> Value of dollar appreciates -> X down & M up -> D down -> weaker economy

question

What are the determinants of exchange rates in the short-run? In the long-run?

answer

SR -> Supply & Demand LR -> Law of One Price (identical goods will be priced the same after exchange rates)

question

What is purchasing power parity theory?

answer

PPP is when exchange rates adjust in the LR to equalize prices. Determines major exchange rates in LR.

question

Why do we have a current account deficit, and what does it imply?

answer

Because M > X It implies that the country has a strong currency and can import a lot, but cannot export as much as their goods/services are too expensive for other countries

question

Why do we have a current account deficit, and what does it imply?

answer

Because M Because M > X It implies that the country has a strong currency and can import a lot, but cannot export as much as their goods/services are too expensive for other countries

question

What are the advantages of floating exchange rates? Fixed exchange rates?

answer

Floating/Flexible Advantages - Shock absorber -> currency depreciation to adjust to weaker economy - Greater insulation from other country's problems Fixed Advantages - More certainty - Better for international trade

question

The 'tri-lemma'? Twin deficit?

answer

Only 2 of the 3 can be achieved: - fixed exchange rates - capital mobility - monetary policy control Gov budget deficit may lead to current account deficit

question

How does a strong currency affect the domestic economy?

answer

It causes imports to increase, while exports decrease causing a current account deficit/financial account surplus (bad). It doesn't always cause a domestic economy to go down if people in the country still purchase domestic goods at the same rate rather than switching to foreign goods.

question

Classical Economics

answer

- Say's Law - Supply creates demand - Focuses on LR supply - Economy self-adjusting - Ms only affects price and inflation - interest rate determined by S and I

question

Keynesian Economics

answer

- Focuses on SR - Focuses on AD - Economy is NOT self-adjusting; periods of recession & unemployment - Use of fiscal policy to increase AD to get through recessions - Ms ultimately affects D as it affects i and I

question

Supply side Economics

answer

Believed in tax cuts to affect supply More production shifts supply curve out to create an expansionary effect

question

Monetarism

answer

- Milton Friedman - SR = Based on an idea of Ms affecting AD and ultimately affecting output and recessions - LR = Essentially classical

question

Rational Expectations

answer

People make optimal economic forecasts leading to a classical outcome

question

What is a government budget deficit? The national debt?

answer

Gov budget deficit is when Expenditures > Revenue National debt is the money a country owes due to borrowing from other countries

question

What harm do Long-run Government Budget Deficits cause?

answer

Crowding out of possibly more productive private sector investments

question

What is meant by Trickle-down economics

answer

Helping the rich get richer so they spend more so the poor can benefit too, in theory Rich get fat, poor get bread crumbs

question

What are government entitlement programs and what LR issues do they raise?

answer

Programs from the government - Medicare (health insurance for seniors. Contribute through working years and draw in during retirement) - Medicaid (health insurance for low income) - Social Security (social insurance and benefits) - CHIPS (health coverage for low income children) - SNAP (food stamps) LR issue = crowding out as there will be a reduction in economic growth as there will be less people replacing the baby boomers

question

What is the largest source of federal government revenue? Largest spending item?

answer

Taxes (income tax and payroll tax) Social Security and Unemployment & Labor

question

What's A Speculative Asset Bubble?

answer

When the price of an asset goes up really fast and is not justified by economic fundamentals

question

What were Tulip Mania, the South Seas Bubble, U.S. Banking Panics, the Dot com bubble, the 21st century housing bubble?

answer

They were all speculative asset bubbles

question

leverage (define and how was it a factor in a crisis)

answer

Using own money mixed with loans to increase profits which increases risk too Performed in the housing market bubble as everyone thought prices would constantly rise

question

securitization (define and how was it a factor in a crisis)

answer

Converting non-tradable assets into tradable ones (mortgages -> bonds). Ex.) Mortgage backed securities were popular, but loans were given to sub-prime credit holders

question

Derivatives

answer

financial assets whose values derive from another...such as mortgage backed securities

question

Shadow Banking

answer

When intermediaries are less regulated, therefore they can leverage more -> increasing risks of losses Ex.) too big to fail

question

What monetary policy actions were taken to deal with the crisis of the 2008 recession?

answer

- Provided liquidity (discount rate and fed fund rate almost to 0) - Provided finance and capital - Expanded Ms and did Quantitative Easing

question

What fiscal policy actions were taken to deal with the crisis of the 2008 recession?

answer

Federal government spending and tax policies to stabilize the economy

question

What were some of the major consequences of the 2008 crisis?

answer

The economy would have contracted for more than 3 years, almost twice as long as it did Unemployment would have been 16% instead of 10% Economy would be much worse if no fiscal or monetary policies were implemented.

question

What is Dodd-Frank? The Volcker Rule?

answer

Dodd-Frank = Created after 2008 recession to regulate banks. Created FSOC Volcker Rule = Part of Dodd-Frank & states that financial banks cannot make certain speculative investments on behalf of their clients.

question

What caused the great depression? The 2007-09 recession?

answer

Great Depression = caused by bank failures and stock market crash of 1929 2008 Recession = Housing Bubble bursts; loans were given out to subprime credit holders.

question

Who was Adam Smith? Milton Friedman? Malthus? Schumpeter? Keynes?

answer

Adam Smith: created the invisible hand; advocated for Laisse Faire Milton Friedman: Created Monetarism; believed economy was driven by Ms Malthus: Believed population grows faster than food (Malthus Law); Also, fixed resources leads to a decline in GDP per capita, no growth (Malthusian) Schumpeter: Talked about creative destruction (something new always replaces something old) Keynes: Father of Macro, focuses on SR and demand side, and advocate for fiscal policies

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