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71 Cards in this Set

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Business Cycle - Long Run: Price, Y and Employment
LR: Price is flexible; Y & employment are at "natural" levels
Business Cycle - Short Run: Price, Y, and Employment
P is "sticky"
shocks and shifts push Y & employment away from natural levels
Business Cycle: Shape of AD, LRAS and SRAS curves
AD slopes down
LRAS is Vertical
SRAS is Horizontal
Shocks to AD or AS cause---
fluctuations in GDP and employment
How are fiscal and monetary policy used?
to stimulate or stablize the economy
The Goods market -->
IS (investment-saving) curve
Y=C+G+I (Closed Economy -- NX = 0)
The money market -->
LM (liquidity-money) curve
Definition of IS curve
Y-r combinations where Goods Market is in equilibrium
Define Keynesian Cross
the equilibrium where output = expenditure (Y=E)
planned expenditure
income, how much money able to spend
Draw the basic graph for the Keynesian Cross
2 equations:
1.) E = Co - mpcT + G+ I + mpcY
slope = mpc
2.) E=Y (m=1)
Using the Keynesian Cross; how can we rewrite the equation to solve for Y in terms of Eo?
derived from original equation E=Y=C+G+I
How does output change from a change in Eo?
(1/1-mpc) = Eo multiplier
How does a change in Co, G, or I affect Eo?
Any change in Co, G, or I changes Eo by the same amount
Causes of increase in G, Co, I (real life)
increase in G --> Govt spending
increase in Co--> consumer confidence
increase in I --> interest rate
Effects of change in T(taxes) on Eo?
Any change in T changes Eo by negative marginal propensity to consume X change in T
(taxes cause consumers to spend less but not dollar for dollar)
What is the relationship of I and I(r)?
Negative relationship between I and I(r)
(Change in I shifts E curve up if positive, down if negative)
Graph I as a function of r
Given an equation:
Example: I(r) = 1000 - 100r
Graph changes in Y, E, and I when r (interest) goes up
if interest goes up then Y decreases, E decreases, I decreases
Graph a basic IS curve
downwards sloping, relates Y to r
Graph change in IS when G increases
Shifts to the right
Graph changes in IS when T increases
shifts to the left
Graph changes in IS curve when r increases
move along curve up and left (NO SHIFT)
What is the equation for IS curve
Y as a function of r
Equations for LM curve
LM Curve is a function of Y, r
IS curve: when Y increases, what happens to S? (if mpc<1)
As long as mpc<1 then as Y increases, S increases
Derive the IS curve from the market for loanable funds (Saving = Investment)
What is the LM curve?
The Money Market
Y-r combinations where real money market is in equilibrium (P fixed)
Real money supply with LM curve
Vertical line; P is fixed and M is fixed
Real Money Demand
Money Demand = L(r) for a given Y
Properties of Real Money Supply Curve = M/P (M, P fixed)
1. P is fixed ("sticky")
2. M is fixed at M, money supply exogenous
3. At any interest rate, the real money supply is the same -->
4. (M/P)s is a vertical line
Properties of (M/P)d = L(r)
r is the cost of holding money, so as r increases money demanded decreases (for a given Y); downwards sloping
Properties of the LM curve
Relationship between r and Y where Real Money supply = Real Money Demand
Set of Y-r pairs where money market is in equilibrium
Upward sloping
Show effects of increase of money demand on LM curve
increase in real money demand forces the interest rate up, increase in Y
Equations for both the IS and LM curve
IS curve: Goods Market Equilibrium
LM curve: Money Market Equilibrium
Effect of increase in capital for individual?
Population increase causes loss of capital/investment for individual person since the wealth has to be shared amongst other workers
Graph the changes to consumption and steady state capital due to an increase in population
increase in population leads to a decrease in both capital and consumption and output
what is the equation for change in k (solow growth)
output - decrease in capital (depreciation, pop growth, growth rate)
what is the total GDP growth rate equal to?
g + n
(each worker is getting more effective, there are more of each of these workers)
how do you find the steady state?
i = outflow
sf(k) = (&+n+g)k
Equation for steady state using production function and how changes in variables effect k*
Note that per worker production function y = f(k) = Ak^(alpha)
Golden Rule (equations)
golden rule: optimize over the steady state consumption
What is the growth rate and technological progress rate at the steady-state?
At the steady-state, the per “effective worker” growth rate is zero. Technological progress rate is positive (g)
GDP per worker growth rate is technological progress rate, g>0, population growth rate is positive (n)
What is money?
Stock of assets that can be readily used to make transactions.
Function of Money (3)
1. Medium of exchange (transactions--replaces barter)
2. Unit of account (measures value; goods and services measured in $)
3. Store of value
2 types of money
1. Fiat money "paper money"
2. Commodity Money; money that has value itself (gold, cigarettes)
C =
M1 =
Currency, Demand Deposits, Travelers Checks, Other Checkable Deposits
M2 =
M1, Savings Deposits (inc. MMDA), Small Time Deposits, MM Mutual Funds (retail)
M2, Large Time Deposits, Repurchase Agreements, Eurodollars, MM Mutual Funds (institutional)
What is V?
Velocity: Number of times the Average dollar changes hands in a given period
Quantity Theory of Money/Quantity Equation
M x V = P x Y
Money Supply (equation)
M = C + D
Money = currency + deposits
Monetary Base = ?
B = C + R
Monetary Base = Currency + reserves
100 Percent Reserve Banking
All deposits held in a bank must be kept in the bank (reserves) available for withdrawal; no loans
Fractional Reserve Banking
Some fraction of deposits is kept in the bank (reserves) available for withdrawal; balance is loaned out. Consider this repeated in multiple banks
T = ?
Transactions: Total value of transactions
M x V = T
(Note: Transactions is "similar" to nominal GDP)
m = ?
monetary base
What is the effect of a decrease in the reserve ratio on the monetary base and money supply?
decrease in reserve ratio is an incrase in money supply
What is the effect on MS when you buy bonds?
increases the quantity of money (--> Drives down the interest rate)
What is the effect on MS when sell bonds?
decreases the quantity of money (M/P)s curve shifts to the left)
3 types of monetary policy
1. reserve requirements
2. Open Market Operations
3. Discount Rate
Open Market Operations (OMO)
buy and sell govt bonds (type of monetary policy)
Discount rate
Interest rate charged by fed. reserve for loans to banks
(type of monetary policy)
Does Money Supply depend on the interest rate?
No, that's why the MS curve is vertical because it is independent of the interest rate
INflation rate =?
Inflation rate measures the % increase in the price index per period
Fisher equation for nominal interest rate and real interest rate
nominal = real + inflation
What is the rltnsp between real money demanded and the interest rate?
Negative relationship between real money demanded and interest rate
positive relationship to Y
Money Demand = ? (In terms of nominal interest rate)
Money Demand depends on interest rate and Y
What is the Money Supply and Money Demand Equilibrium?
Summary of LR Business Cycle Theory
Prices Adjust, changes in Demand cause immediate changes in prices, leaving output and income unchanged at F(K, L)
Summary of SR Business Cycle Theory
Prices are "Sticky", changes in Demand do not move prices so inventories fluctuate causing production changes