Essay questions and comparative analysis approaches

Aggregate expenditure multiplier is the ratio of the change in the aggregate output (or in the gross domestic product) to the change calculated for an aggregate expenditure that is derived from investment expenditures, government purchases, net exports, or consumption expenditures). The expenditure multiplier is a concept derived from classical economics and is central to macroeconomic analysis.

The importance of the idea of the multiplier is that it demonstrates that even a small shift in one part of an economic system can (through the effect of multipliers) have a dramatic effect throughout the entire system. Given even a small change in a form of expenditure (such as in any of a range of possible investment types) can at the end of an economic chain of exchanges can result in a very large change in the aggregate output. While it is hard to predict with any precision how large the degree of the effect of the multiplier (this is essentially a part of the definition of the multiplier effect), its value can be extrapolated from the marginal propensity of a population to consume the service or good at hand. If one can calculate the value of an expenditure multiplier then one can ascertain with relative accuracy the level of a certain type of expenditure (usually government input of some sort) to meet an end goal of aggregate output, such as a decrease in unemployment.

2. Name the three policy tools of the Federal Reserve.

The Federal Reserve has three powerful tools to guide monetary policy in the United States: Open market operations, reserve requirements, and the discount rate. Open market operation is a tool for implementing monetary policy through the control of a short-term interest rate by a central bank (or its equivalent). Open market operations also include control over the supply of base money in an economy. These two controls in conjunction with each other control the total money supply in the system. This in turn means that the Federal Reserve needs to meet the demand to supply sufficient base money at a particular target rate through the manipulation of various financial instruments such as government bonds.

The reserve requirement that the Federal Reserve sets requires all commercial banks to have certain cash reserves held against customer deposits. These reserves are surrendered to the central bank, usually stored as fiat currency in a vault.

Finally the discount rate is the interest rate that a central bank such as the Federal Reserve charges the depository institutions that borrow reserves from the central bank. Depository institutions are any type of establishment that has the right to take deposits from a customer, such as a commercial bank, a credit union, or a savings and loan.

3. Rate of inflation vs. aggregate demand.

The concept of inflation is one of the most important and basic ideas in economics. It is simply any overall rise in the price for goods and services in a given period of time (most often a year). Inflation is also one of the few economic concepts that is generally understood and watched by the lay public because when the general level of prices rises, people's wages can buy less and less of the goods and services that they need. Thus inflation can thus also be seen as a devaluation of the purchasing power of money. The inflation rate is an annualized rate that designates the percentage change over time in the general price index of an economy. (in the United States, this general price index is the Consumer Price Index.)

Aggregate demand is an important concept within macroeconomic theory. It designates the total demand within an economy for both services and goods at any given point of time and as assessed at a specific price level. This concept is also designated as the effective demand and can be seen as the total demand for the gross domestic product of an economy if inventory levels are being held at a static level.

When it is graphed, the aggregate demand curve always slopes downwards. This is not because of the fact that as prices fall the demand for a service or good grows. Rather, it is a much more complicated equation based on a convergence of different conditions of distribution of wealth, exchange rates, and interest rates.

Extra Credit Question: Discussion of money as a storage of value and as neutral.

The storage of value is one of the key functions that money has had since its first use in ancient human society. Money in its function of storage of value serves as a sort of proxy for other kinds of wealth. Before the widespread use of currency, land, precious metals and gems, finely crafted goods and art, and livestock were all used to store value. As should be obvious to anyone, money is far more portable than these other forms of wealth.