Exam Revision Flashcards Preview

Macroeconomics > Exam Revision > Flashcards

Flashcards in Exam Revision Deck (249)
Loading flashcards...
211

Supply side economics

Tax policy and work incentives

Fiscal policy and AS curve

212

Tax policy and work incentives

A decrease in tax rates may cause individuals to work more because they get to keep more of what they earn. The aggregate supply curve would increase (shift to the right). However most economists believe that a cut in tax rates only has a small effect on the AS curve

213

Fiscal policy and AS curve

If the government increases spending on capital projects or education, the productive ability of the economy is enhanced, shifting aggregate supply to the right.

214

Using policy to stabilise the economy

Active stabilisation economy

Automatic

Against active stabilisation policy

215

Active stabilisation policy

The level of aggregate demand can be influenced by a change in government spending or taxation (fiscal policy) or a change in the interest rate (monetary policy). Keynesians believe that it is necessary for the central government to use its tax, government purchase ad interest rate (open market operation) policies aggressively to stimulate the economy during recession and slow the economy down during inflationary times.

216

Automatic

Fiscal policy

Government spending

Tax system

217

Fiscal policy

Changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policymakers having to take any deliberate action.

218

Government spending

Government spending is also an automatic stabiliser. More individuals become eligible for transfer payments during a recession. E.g. unemployment payments to the unemployed.

219

Tax system

The most important automatic stabiliser is the tax system. The government's revenue falls during a recession. Tax cut stimulates aggregate demand and reduces the magnitude of this economic downturn.

220

Against active stabilisation policy

Fiscal and monetary policy tools should only be used to help the economy achieve long run goals such as low inflation and economic growth. Policy tools may affect the economy with a large time lag.

221

Policy tools may affect the economy with a large time lag.

With monetary policy, investment decisions are usually made well in advance, so the effects from changes in investment will not likely be felt in the economy very quickly.

With fiscal policy the lag is generally due to the political process. Changes in spending and taxes must be approved by both the House and the Senate.

222

How monetary policy influences aggregate demand

The aggregate demand curve is downward sloping.

The theory of liquidity preference

223

The aggregate demand curve is downward sloping

3 reasons

Pigou's wealth effect

Keyne's interest rate effect

Mundell-flemings exchange rate effect

224

Pigou's wealth effect

Keyne's interest rate effect

Mundell-flemings exchange rate effect

All three effects occur simultaneously but are not of equal importance. Household's money holdings are a small part of the total wealth (small wealth effect). Imports and exports are a small fraction of Australian GDP, the exchange rate effect is also fairly small for Australia. The most important reason for the downward sloping aggregate demand curve is the interest rate effect.

225

The most important reason for the downward sloping aggregate demand curve is the interest rate effect.

A higher inflation rate induces the RBA to reduce interest rate. A higher interest rate reduces the quantity of goods and services demanded.

226

The theory of liquidity preference

An explanation of the supply and demand for money and how they relate to the interest rate. 29/9

The money supply is assumed to be controlled by the central bank. Since the money supply does not depend on other economic variables, it's a vertical line.

Interest rate is the opportunity cost of holding money. As the interest rate rises the quantity of money demanded will fall. Therefore, the demand for money will be downward sloping.

227

5. Which of the following policies would Keynes have supported when the economy is experiencing unemployment?
a. An open-market purchase
b. A reduction in tax rates
c. An increase in government purchases
d. All of the above

Keynes would have supported a policy that directly increases spending within the economy. An open market purchase by the RBA would lower interest rates, encouraging increased consumption and investment spending. A reduction in tax rates would encourage greater consumption spending. An increase in government purchases would directly contribute to an increase in national expenditure. Thus, Keynes would have supported all the possible options presented here.

228

9. Why do people still hold cash in their wallets, despite the fact that they receive no returns compared to storing cash in their bank accounts?

According to the liquidity preference theory, people hold cash because it is by far the most liquid asset for completing transactions. In other words, people derive the benefit from holding cash not by receiving interest payments; the benefit flows through in the form of convenience.

229

10. What are the key determinants of the interest rate in the short run? What are the key determinants of the interest rate in the long run?

In the short run, we can think of the interest rate as being determined in the money market, so its key determinants are the supply of and demand for money. In the long run, we can think of the interest rate as being determined in the loanable funds market, so its key determinants are the supply of and demand for loanable funds.

230

11. What are the impacts of an expansionary fiscal policy on output and the inflation rate in the short run? How about in the long run?

An expansionary fiscal policy will raise both output and the inflation rate in the short run. However, without corresponding changes to long-run aggregate supply, such a policy will only lead to a permanent increase in the inflation rate.

231

12. Define expansionary and contractionary fiscal policy, giving examples of each.

expansionary = a planned decrease in the budget surplus (T-G); e.g. a tax cut

contractionary (or tight) = a planned increase in the budget surplus (T-G); e.g. reduced government spending without any reduction in taxes

232

The flow of financial resources: Net foreign investments

The purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners.

233

Foreign direct investment

A capital investment is owned and operated by a foreign entity.

234

Factors that influence a country's net foreign investment

The real interest rate being paid on foreign assets

The real interest rates being paid on domestic assets

The perceived economic and political risks of holding assets abroad

The government policies that affect foreign ownership of domestic assets

235

The international flow of goods:

Exports are goods and services that are produced domestically and sold abroad.

Imports are goods and services that are produced abroad and sold domestically.

Net exports NX refers to the value of a nation's exports minus the value of its imports, also called its trade balance.

236

Trade balance

The value of a nation's exports minus the value of its imports.

A trade surplus refers to an excess of exports over import.

A trade deficit refers to an excess of imports over exports.

Balanced trade refers to a situation in which exports equal imports.

237

Factors that influence a country's exports, imports and net exports

The taste of consumers for domestic and foreign goods

The prices of goods at home and abroad

The exchange rates at which people can use domestic currency to buy foreign currencies

The incomes of consumers at home and abroad

The cost of transporting goods from country to country

The policies of the government toward international trade

238

Saving and its relationship to international flows

Saving is equal to the sum of domestic investment and net foreign investment

S = I + NFI

239

The prices for international transactions

Real and nominal transactions

240

Nominal exchange rate

The rate at which a person can trade the currency of one country for the currency of another.

Appreciation refers to an increase in the value of a currency as measured by the amount of foreign currency it can buy

Depreciation refers to a decrease in the value of a currency as measured by the amount of foreign currency it can buy