Macroeconomics Basics

Question: The exchange rate between the domestic and a foreign currency is determined by…

Answer: Just like the price of any good, the exchange rate (which is the price of the domestic currency relative to a foreign currency) is also determined by the laws of supply and demand. For example, the higher the demand for US dollars, the more valuable the US dollar will be, resulting in a higher exchange rate for the US dollar vs. the other currencies.

Question: The largest component of the gross domestic product (GDP) is...

Answer: Consumption expenditures by households is the largest component of GDP, making up roughly 2/3rds of it.

Question: If the central bank of a country decides to reduce the short-term interest rates, this likely means that…

Answer: Reducing short-term interest rates represents an expansionary form of monetary policy. The aim of expansionary policies is to boost output in the short run, most likely to avoid a possible upcoming recession.

Question: In macroeconomics, the negative relationship between an economy’s unemployment rate and output (GDP) is referred to as…

Answer: Okun’s law, named after Arthur Okun, summarizes the negative relationship between unemployment and output. According to one version of the law, every 1% increase in unemployment results in 2% lower output than potential.

Question: Laissez-faire economists advocate…

Answer: "Laissez-faire" in economics is a term that is used to describe the absence of government intervention in free markets. Laissez-faire economists strongly oppose any form of government intervention.

Question: In macroeconomics, the negative relationship between inflation and unemployment is summarized by...

Answer: The Phillips curve, first proposed by economist William Phillips in 1958, depicts a negative relationship between inflation and unemployment: a higher inflation rate in an economy usually implies a lower unemployment rate, and vice versa.

Question: Printing money and distributing it to all people is not a viable solution to heal world-wide poverty because…

Answer: Printing money is very easy and costs very little for central banks. However, it cannot be a solution to end poverty because it will result in inflation (price increases). Over time, inflation will wipe away any increase in income that resulted from the money distribution.

Question: In macroeconomics, the business cycle refers to…

Answer: The business cycle refers to fluctuations in the level of output. Consecutive increases in output are called expansions, whereas consecutive decreases are referred to as recessions.

Question: The school of thought in economics that believes that a government should proactively respond to economic recessions by increasing public expenditures to boost demand is…

Answer: The Keynesian School, founded by British economist John Maynard Keynes during the Great Depression era, proposes active government intervention during economic downturns.