# Macroeconomic Policy, Open Economy Macroeconomics & Strategic Interaction

> 32 review cards on fiscal and monetary policy transmission, AD-AS and IS-LM frameworks, Phillips curve dynamics, balance of payments, exchange-rate regimes, comparative advantage, and strategic game theory.

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- **Level:** advanced
- **Languages:** en → en
- **Total Cards:** 32

## Flashcards (32 Cards)

| # | Front (Term / Prompt) | Back (Definition / Answer) | Example | Multiple-Choice Options |
| :--- | :--- | :--- | :--- | :--- |
| 1 | What is a Nash equilibrium? | A strategy profile in which no player can increase their expected payoff by changing only their own strategy while others keep theirs unchanged. It can involve pure or mixed strategies. Equilibrium does not necessarily mean an efficient, fair or jointly best outcome. |  |  |
| 2 | Why does the twin-deficits hypothesis not follow automatically from an accounting identity? | In a simplified open economy, NX = (Sₚ − I) + (T − G), where Sₚ is private saving and T net taxes. A larger fiscal deficit reduces NX only if private saving and investment do not offset it. More generally, the current account equals national saving minus investment; it also includes cross-border income and transfers. |  |  |
| 3 | What is tit-for-tat in a repeated prisoner's dilemma, and what is a limitation? | Cooperate first, then copy the opponent's previous action. It rewards cooperation and promptly answers defection, but a mistaken move can trigger alternating retaliation. Its success depends on the opponent, payoffs, patience and errors; it is not automatically optimal or a subgame-perfect equilibrium. |  |  |
| 4 | What does Ricardian equivalence predict about a debt-financed tax cut? | With government spending unchanged and strong assumptions such as forward-looking households, nondistortionary taxes and unrestricted borrowing, households save the tax cut to meet future tax liabilities, leaving consumption unchanged. Borrowing constraints, finite planning horizons and uncertainty can break this result. |  |  |
| 5 | How do automatic stabilizers cushion a recession? | Existing tax and benefit rules make tax receipts fall as incomes decline and some transfers, such as unemployment benefits, rise as eligibility increases. They support disposable income without a new discretionary law. This does not require a cut in statutory tax rates or an increase in government purchases. |  |  |
| 6 | What is a strictly dominant strategy? | A strategy that gives its player a strictly higher payoff than each alternative strategy for every possible strategy choice of the opponents. Not every game has one. Strict dominance differs from being a best response only to a particular opponent strategy. |  |  |
| 7 | What is stagflation, and how can an adverse supply shock produce it? | Stagflation combines high inflation with weak output growth and high unemployment. In AD–AS analysis, a cost-increasing supply shock shifts short-run aggregate supply left/up, raising the price level while reducing output. This is one explanation, not the only possible history of stagflation. |  |  |
| 8 | What is comparative advantage, and how does it allow gains from trade? | A producer or country has comparative advantage in a good when its opportunity cost is lower. Specialization and exchange at suitable relative prices can expand consumption possibilities even if one country is more productive in every good. Aggregate gains do not guarantee that every person benefits. |  |  |
| 9 | Why can a liquidity trap weaken conventional monetary expansion? | Near the effective lower bound, money and short-term safe bonds may be close substitutes, so exchanging bonds for money has little effect on short rates or spending. The bound need not be exactly zero. Forward guidance and purchases of other assets can still affect expectations and financial conditions. |  |  |
| 10 | What trade-off does the expectations-augmented Phillips curve imply? | For given expected inflation and supply conditions, lower unemployment can accompany higher inflation in the short run. As expectations adjust, the standard model has no permanent inflation–unemployment trade-off; its long-run curve is vertical at the relevant equilibrium unemployment rate. Expectations and supply shocks can shift the short-run curve. |  |  |
| 11 | What is the open-economy policy trilemma? | A country cannot fully combine a fixed exchange rate, unrestricted international capital mobility and independent monetary policy. Committing to two constrains the third. Partial controls and managed exchange rates create intermediate arrangements, not a way to obtain all three without trade-offs. |  |  |
| 12 | What does the LM curve represent when the nominal money supply is fixed? | Combinations of nominal interest rate i and real output Y satisfying M/P = L(i, Y). With prices fixed, money demand rising with income and falling with i, higher output requires a higher interest rate. A liquidity trap or an interest-rate-targeting central bank changes this textbook upward-sloping relationship. |  |  |
| 13 | How does the U.S. Federal Reserve steer short-term rates in an ample-reserves framework? | It primarily adjusts administered rates, especially interest on reserve balances (IORB). The overnight reverse-repo facility supports a lower bound for eligible counterparties; standing repo operations help limit upward pressure. Balance-sheet operations maintain suitable reserve supply. These are U.S. arrangements, not a universal central-bank toolkit. |  |  |
| 14 | How does monetary expansion affect the standard fixed-price IS–LM model away from a liquidity trap? | An increase in real money balances shifts LM down/right. With IS unchanged, the interest rate falls and equilibrium output rises through interest-sensitive spending. Expected inflation is held fixed when interpreting the real borrowing rate. This is a conditional model result, not a complete account of modern policy implementation. |  |  |
| 15 | What is the lump-sum tax multiplier in the same simple Keynesian-cross model? | ΔY/ΔT = −MPC/(1 − MPC). A tax increase reduces equilibrium output; a tax cut raises it. Its absolute value is smaller than the government-purchases multiplier because only the MPC share of the initial disposable-income change is consumed. The comparison depends on the model's assumptions. |  |  |
| 16 | What does the simple deposit multiplier 1/rr assume? | In a stylized reserve-constrained model, rr is a positive reserve ratio and deposits expand by up to 1/rr times an added reserve amount, assuming no cash drain, no excess reserves and sufficient lending demand. This is not a general description of modern bank lending: loans create deposits, subject to capital, liquidity, risk and demand constraints. |  |  |
| 17 | What does MV = PY establish, and what extra assumption produces a quantity-theory prediction? | With V defined as income velocity, MV = PY is an accounting relation: money times velocity equals nominal output. If V is stable and real output Y is determined independently of money, sustained money growth beyond real-output growth implies inflation. The identity alone does not prove causation or fixed short-run velocity. |  |  |
| 18 | What is subgame-perfect Nash equilibrium, and when is backward induction applicable? | Strategies must form a Nash equilibrium in every subgame, including ones not reached on the equilibrium path. Backward induction finds such equilibria in finite games of perfect information. Infinite or imperfect-information games generally require other methods or additional analysis; subgame perfection is broader than backward induction. |  |  |
| 19 | What creates the dilemma in the standard one-shot prisoner's dilemma? | Defection is strictly dominant for each player, so mutual defection is the Nash equilibrium. Yet both players would receive higher payoffs under mutual cooperation. Individually optimal responses therefore produce an outcome worse for both than feasible cooperation. |  |  |
| 20 | What does the standard Heckscher–Ohlin model predict about trade patterns? | A country exports goods intensive in its relatively abundant factor and imports goods intensive in its relatively scarce factor. The standard model assumes conditions such as common technologies, identical homothetic preferences (income-independent spending shares at fixed prices) and factors mobile between domestic industries but not internationally. It is a conditional prediction, not a universal empirical rule. |  |  |
| 21 | What does the IS curve represent in the textbook IS–LM model? | Interest-rate/output combinations where planned spending equals output in the goods market. With expected inflation held fixed and investment sensitive to borrowing costs, a higher interest rate reduces planned investment and equilibrium output, giving a downward-sloping IS curve. The open-economy version also includes net exports. |  |  |
| 22 | What does the Stolper–Samuelson theorem say about goods prices and factor returns? | In the standard two-good, two-factor model with both goods produced, a rise in a good's relative price raises the real return to the factor used intensively in that good and lowers the other's real return. Abundant-factor gains from trade require additional assumptions about which relative price rises. |  |  |
| 23 | How are the three balance-of-payments accounts related under the IMF financial-account sign convention? | The current account records goods, services, income and current transfers; the capital account records capital transfers and nonproduced nonfinancial assets. The financial account (FA) is net asset acquisition minus net liability incurrence. Ideally CA + KA = FA; measured data use CA + KA + net errors and omissions = FA. |  |  |
| 24 | How do covered and uncovered interest parity differ? | With spot S and forward F quoted as domestic currency per foreign unit, covered parity gives F/S = (1 + iᴅ)/(1 + iꜰ) for comparable maturities and ideal arbitrage conditions. Uncovered parity substitutes expected future spot for F and requires additional risk assumptions. Neither makes actual future exchange rates certain; real markets can depart from parity. |  |  |
| 25 | Why does aggregate demand usually slope downward in the standard AD–AS model? | Other things equal, a lower price level raises the purchasing power of nominal wealth and can lower interest rates, supporting consumption and investment. Lower domestic prices relative to foreign prices can also support net exports. These channels depend on the monetary and exchange-rate setting. |  |  |
| 26 | Why is long-run aggregate supply vertical in the standard AD–AS model? | After wages and other prices adjust, a change in the overall price level alone does not change potential real output. Potential output depends on productive resources, technology and institutions; it can change over time. Vertical LRAS is a model assumption, not a claim that output can never exceed potential temporarily. |  |  |
| 27 | What is absolute purchasing-power parity, and what limits it? | For S measured as domestic currency per foreign currency unit, absolute PPP states S = Pᴅ/Pꜰ for comparable price baskets. Transport costs, trade barriers, nontradable goods and different baskets can cause departures. PPP is a benchmark, not a guarantee that market exchange rates immediately equal basket-price ratios. |  |  |
| 28 | How do tariffs and import quotas differ in who receives revenue or rents? | A tariff generates government revenue on imports actually made. A binding quota creates scarcity rents that may go to license holders or exporters; auctioning licenses can transfer rents to government. Neither the rent allocation nor tariff revenue equals every part of the domestic price increase in all settings. |  |  |
| 29 | What is the government-purchases multiplier in the simplest Keynesian cross? | ΔY/ΔG = 1/(1 − MPC), where 0 < MPC < 1. This closed-economy model assumes fixed prices, lump-sum taxes, autonomous investment and no interest-rate feedback. Imports, income-dependent taxes, capacity limits and policy responses can change the multiplier. |  |  |
| 30 | How do the textbook Cournot and Bertrand duopoly models differ? | Cournot firms choose quantities; Bertrand firms choose prices. With identical products, equal constant marginal costs and no capacity constraints, the basic one-shot Bertrand model gives price equal to marginal cost. With downward-sloping demand and positive equilibrium output, the corresponding standard Cournot duopoly has a markup. Product differentiation, capacity limits or repeated interaction can change these results. |  |  |
| 31 | Write a common Taylor-rule benchmark and define its output-gap term. | i = r* + π + 0.5(π − π*) + 0.5g, where i is the nominal policy rate, r* the equilibrium real rate, π inflation, π* its target and g = 100(Y − Y*)/Y* the percentage output gap. Enter rates as percentages; differences between inflation rates are measured in percentage points. This benchmark is not a rule every central bank mechanically follows. |  |  |
| 32 | What is fiscal crowding out, and is it inevitable? | Government borrowing can raise interest rates and reduce private investment or other interest-sensitive spending. The size depends on spare capacity, monetary policy, capital flows and how funds are used. It need not fully offset fiscal stimulus, and public investment can sometimes encourage private investment. |  |  |

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