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181 Cards in this Set
- Front
- Back
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Funds into Govt |
taxes and borrowing |
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Funds out of Govt |
government purchases and transfers to households |
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gov revenue in 2013 from all taxes |
43% |
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Government transfers |
social security, medicare, medicaid |
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Social Insurance |
gov programs intended to protect families in economic hardship |
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Disposable Income |
the total income households have to spend after taxes and transfers (includes dividends, rent, and interest |
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decreases disposable income |
increase in taxes or reduction in transfers |
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increases in disposable income |
decreases in taxes or increases in transfers |
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Expansionary Fiscal Policy |
Policy that increases demand (increase in gov purchases of goods and services, cut taxes, increase in gov transfers) |
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Arguments against fiscal policy |
government spending always crowds out private spending, government borrowing always crowds private investment spending and government budget deficits lead to reduced private spending |
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crowding out in private spending |
only happens at full employment |
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Crowding out in private investment |
only happens when economy is not depressed |
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depressed/underemployed economy and expansionary policy |
people save more and gov can borrow with out raising interest rates |
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Ricardian Equivalence |
borrowing for expansionary policy leads to higher debt -> higher taxes -> decrease in spending and higher savings |
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time lags |
Time between when fiscal policy is decided and when it is implemented |
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Lags in Fiscal Policy |
economy may recover before policy is implemented and helps develop an inflationary gap when policy takes effect (interest rates can increase) |
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direct effect of Govt spending |
increase in final G&S by same amount |
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indirect effect of govt spending |
firms associated with gov purchases earn revenue= increase wages, profits, rent and interest in households= increased consume spending |
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gov effect on GDP |
gov spending x multiplier *1/(1-MPC)* |
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Relation of changes in gov transfer and taxes and govt purchases |
transfers and taxes have lesser effect |
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govt transfer and tax multiplier |
(MPC/(1-MPC)) |
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Lump sum taxes |
Taxes that depend on the tax payers income (imposes no change in multiplier) |
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tax (non-lump sum) revenue |
relies real GDP (lowers the multiplier) |
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MPC of low and unemployed persons |
Higher than those who are wealthy |
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tax laws and rising tax revenues |
causes increases in real GDP |
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Automatic stabilizer: |
government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands |
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Effect of automatic increases in tax revenue |
reduces size of multiplier |
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multiplier is result of |
chain reaction in which high GDP leads to high income and consumer spending |
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benefit of small multiplier |
lessen the extremities of business cycles |
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Automatic decrease |
decreases in tax revenue and increases multiplier |
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transfer payments rise when |
economy is depressed |
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smaller disposable income |
lower the multiplier |
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Directionary Fiscal Policy |
fiscal policy that is the result of deliberate actions by policy makers rather than rules. |
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Austerity |
cuts in spending and tax increases (condition of aid from other countries) |
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expansionary fiscal policies make |
a budget surplus smaller or budget deficit bigger |
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changes in budget balances |
are results of fluctuations of economy |
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aggregate demand curve |
Relationship between aggregate price level and quantity of aggregate output demanded by households, businesses, the govt, and rest of the world |
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rise in aggregate price level reduces |
C, I, and X-M |
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increase in aggregate price level |
reduces purchasing power |
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Interest Rate Effect |
increase in aggregate price level -> decrease purchasing power -> increase in holdings by borrowing, selling assets and/or bonds -> reduces funds available for lending ->increases interest rates -> decreases investment and consumer spending |
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Shifts of the Aggregate Demand Curve |
Changes in Expectations, Changes in Wealth, Size of Existing Stock of Physical Capital |
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optimistic firms and households |
rise in aggregate spending |
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increases in wealth |
raises aggregate demand |
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the more people have |
the less they feel they need |
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govt and aggregate demand |
effects aggregate demand because they are a component of it |
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gov purchases and aggregate demand shift |
right shift |
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Monetary Policy |
increases in quantity of money, ageggate demand moves right |
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Aggregate Supply Curve |
Shows relationship between the aggregate price level and quantity of aggregate output supplied in the economy. |
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relationship between aggregate price level and aggregate output supplied |
Positive relationship |
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profit per unit of output |
price per unit of output - production cost per unit of output |
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largest source of inflexible production cost |
wages paid to workers |
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Nominal Wage |
the dollar amount of wage paid |
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in informal agreements |
managers are reluctant to change wages |
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wages won’t decrease until (informal) |
long, severe depressions |
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firms won’t increase wages unless (informal) |
unless facing losing workers |
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Sticky Wages |
nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labor shortages |
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fall of sticky wages |
= renegotiation of agreements |
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producer behaviors (when production costs are fixed in short run) |
aggregate price level falls -> price of goods to a producer falls -> decline in profits -> producers reduce supply |
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Shifts of Short Run Aggregate Supply |
Changes in Commodity prices, Changes in Nominal Wages, Changes in Productivity |
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fall in commodity prices |
=increase in supply |
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commodities and final goods |
commodities are not final goods (not included in calculation of aggregate price level) |
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commodities and cost of production |
commodities represent significant cost of production |
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fall in nominal wages |
= increase in aggregate supply |
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rise in productivity |
= increase in aggregate supply |
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why does Long run aggregate price level has no effect on quantity of aggregate output supplied |
products can still be profitable in long run after price changes |
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Potential Output |
Level of real GDP the Economy would produce if all prices, including nominal wages, were fully flexible |
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Long run supply |
= economy’s growth potential |
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aggregate output higher than potential output = |
low unemployment -> nominal wages rise -> short run will shift leftward and vice versa |
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AD-AS Model |
The aggregate supply curve and the aggregate demand curve are used together to analyze economic fluctuations |
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Short Run microeconomic Equilibrium |
when the quantity of aggregate output supplied is equal to the quantity demanded. |
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Short-run equilibrium aggregate price level |
the aggregate price level in the short run macroeconomic equilibrium |
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Short run equilibrium aggregate output |
the quantity of aggregate output produced in the short-run macroeconomic equilibrium |
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Demand Shocks |
event that shifts aggregate demand curve |
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Cause of Demand Shocks |
changes in expectations of wealth, size of existing stock of physical capital, use of physical and monetary policy |
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Supply Shock |
An event that shifts short run aggregate supply curve |
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Cause of Supply Shocks |
change in commodity prices, nominal wages, or productivity |
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Stagflation |
combination of inflation and falling aggregate output (falling output leads to unemployment and purchasing power is reduced by rising prices) |
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Long Run Macroeconomic Equilibrium |
point of short run macroeconomic equilibrium is on long run aggregate supply curve |
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Negative demand shock |
reduces aggregate price level and output -> high unemployment in short run -> fall in nominal wages in long run increases short run aggregate supply and moves economy back to y potential |
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Positive demand shock |
increases aggregate price level and output -> reduces unemployment in short run -> rise in nominal wages in long run reduces aggregate supply in short run -> moves economy back to potential |
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Recessionary gap |
when aggregate output is below potential output |
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Inflationary gap |
when aggregate output is above potential output |
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Output Gap |
percentage difference between actual aggregate output and potential output ((actual aggregate output - potential output)/potential output)x100 |
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Self-Correcting |
when shock to aggregate demand affect aggregate output in the short run but not long run |
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Time for self correction |
self correction takes a decade or more |
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stabilization policy |
use of govt policy to reduce the severity of recessions and rein in excessively strong expansions |
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Increase in investment |
= increase in income and value of aggregate output by same amount |
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increase in aggregate output |
= increase in income in form of profits and disposable wages -> rise in consumer spending -> firms to increase output |
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Marginal propensity to consume |
increase in consumer spending when disposable income rises by $1 |
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MPC |
(change consumer spending/change disposable income) |
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MPC is between 0-1 because |
consumers spend only part of additional dollar |
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Marginal propensity to save |
Increase in household savings when disposable income rises by $1(1-MPC) |
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Total increase in real GDP from a rise in investment or AAS |
(1/1-MPC) x I (or AAS) |
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Wealth Effect |
= increase consumption (before real GDP rises via investment) |
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Autonomous (self governing) change in aggregate spending (AAS) |
an initial change in the desired level of spending forms, housholds, or government at a given level of real GDP. |
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Multiplier |
the ratio of the total change in real GDP caused by an autonomous change in aggregate spending to the size of that autonomous change ((1/1-MPC) and Change in Y/ Change in AAS) |
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Most important factor in family’s consumer spending |
is current disposable income (income after taxes paid and gov transfers) |
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Consumption function |
equation showing how an individual household’s consumer spending varies with the household’s current disposable income (C=a + MPC x yd (disposable income)) |
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Aggregate Consumption Function |
the relationship for the economy as a whole between aggregate current disposable income and aggregate consumer spending (C = A + MPC x YD) |
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Shifts of Aggregate Consumption Function |
Changes in Expected Future Disposable Income and Changes in Aggregate Wealth |
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an increase in A |
= an increase in YD |
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permanent income hypothesis |
consumer spending depends on the income people expect to have in the long run rather than on current income |
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higher current income |
leads to higher savings today |
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higher expected income |
leads to less savings today |
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Life Cycle Hypothesis |
consumers plan their spending over a lifetime - they save their current disposable income during years of peak earnings and then live off of accumulated wealth when retired |
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economic failure |
leads to intellectual progress |
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most recessions and fall in consumer spending are originated by |
fall in investment spending |
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factors in investment spending |
interest rate and expected future real GDP |
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Planned investment spending |
the investment spending that businesses intend to undertake during a given period. |
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interest rates have clearest effect on |
residential construction (homes) |
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Retained Earnings |
past profits businesses use to finance investment spending |
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a rise in market interest makes |
any project investment less profitable |
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Planned investment spending in relation to interest rate |
Planned investment spending is negatively related t interest rate |
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growth of firms |
leads higher investment |
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Investment in non-growing firms |
A firm that doesn’t expect growth will only invest if new technologies make others obsolete or to replace old, worn out structures and equipment |
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a firm with very high capacity will |
not invest until sales catches up with capacity |
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level of capacity and investment |
current level of capacity has a negative effect on investment |
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indicator of expected future sales is |
a future growth rate of real GDP |
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Accelerator Principle |
a higher growth of GDP leads to higher planned investment spending |
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Investment spending slumps |
periods of low investment spending |
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Inventories |
are stocks of goods held to satisfy future sales |
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% of US GDP was in inventories in 2nd quarter of 2104 |
10% |
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The savings investment spending identity |
savings and investment spending are always equal for the economy as a whole |
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Closed economy |
no exports or imports GDP = C+I+G // Total income = Consumption spending GDP= C+G+S S=I |
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Budget Surplus |
Difference between tax revenue and gov spending when tax revenue exceeds gov spending |
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Budget Deficit |
Difference between tax revenue and gov spending when gov spending exceeds tax revenue |
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Budget Balance |
difference between tax revenue and gov spending (Sgov = T-G-TR) |
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National savings |
Snat = Sgov+Sprivate // Snat = Investment |
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Savings Investment In Open Economy |
Goods can flow in and out of country Snat + Net capital inflow |
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Net Captial Inflow |
Inflow - Outflow |
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Loanable funds market |
hypothetical market that illustrates the market outcome of the demand for funds generated by borrowers and the supply of funds provided by lenders |
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Interest Rates |
determine value of the dollar in future compared to dollar today Present value = $Y/(1+interest rate) |
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Future dollars with high current interest rates |
worth less than current dollar |
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Opportunity Cost of investments spending |
Costs are high with high interest -> lower quantity of loanable funds demanded Costs are low with low interest -> higher quantity of loanable funds demanded |
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Equilibrium Interest rate |
Interest rate at when quantity of loanable funds supplied equals the quantity of loanable funds demanded |
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Effiency in |
Right investments get made: spending projects get higher pay offs Right people do saving and lending: savers who lend funds are willing to lend at lower rates |
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Shifts in Demand for loanable funds |
Changes in perceived business opportunities, changes in govt borrowing |
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Demand shift for loanable funds in increase business opportunities |
shifts right |
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Demand shift for loanable funds in increased gov deficit |
borrowing increases -> interest rates rise -> demand shifts left/invest spending decreases -> crowding out |
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Crowding out in depressed economy |
May not happen Decrease production -> increase gov spending -> increase incomes -> increased savings at any interest rates |
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High savings and govt borrowing |
High savings allow govt to borrow a high interest rates |
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Shifts in supply of Loanable funds |
Changes in private savings behavior,changes in net capital flows |
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Increase in wealth effect and supply shift of loanable fund |
higher spending -> save less -> supply shifts left |
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decrease in capital inflows and supply of loanable funds |
supply shifts left |
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Increase supply of loanable funds |
decreases equilibrium -> interest rates fall |
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Real interest rate |
Nominal interest rate - inflation rate |
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True cost of borrowing/ pay off for lenders |
= Real interest rate |
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Predictions of inflation |
influences interest rate |
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Fisher effect |
Increase in expected future inflation drives up nominal interest rate, leaving expected interest rate unchanged |
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1% increase in inflation expected |
= 1% added to nominal rate |
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Change in expected rate of inflation |
does not affect equilibrium quantity of loans or expected real interest, Only expected real interest |
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Wealth |
household value of its accumulated savings |
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Financial assests |
A paper claim that entitles the buyer to future income from seller loans, stocks, bonds |
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Physical Asset |
Tangible object that can be used to generate future income (preexisting/used goods) |
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liability |
requirement to pay income in future |
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Tasks of Financial Systems |
Reduce transaction costs, Reduce risk, providing liquidity |
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transaction cost |
expenses of negotiating and executing a deal |
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transaction costs and borrowing from bank or selling bonds |
decreased transaction costs because one borrower and one lender is invloved |
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financial risk: |
uncertainty about future outcomes that involve financial gains or losses |
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risk averse |
being sensitive to losses |
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diversification |
investing in several different things so possible losses are independent events |
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liquid |
assets that can be quickly converted to cash with little loss of value |
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Loans |
A lending agreement between an individual lender and borrower |
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Good aspect of loans |
tailors to borrowers needs |
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bad aspect of loans |
involves transaction costs |
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Borrowers selling bonds |
minimizing costs |
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Bonds |
an IOU issued by the borrower |
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default |
occurs when borrower fails to make payments as specified by loan or bond contract |
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bonds with high default risk |
have higher interest to attract investors |
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liquidity of bonds |
high liquidity |
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Loan backed securities |
asset created by pooling individual loans and selling shares in that pool |
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Stocks |
share in ownership in a company |
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why companies allow ownership |
to reduce owner risk |
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stock is based on, bonds are based on |
hope, promise |
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financial intermediaries |
institution that transforms the funds it gathers from many individuals into financial assets |
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Mutual Funds |
financial intermediary that creates a stock portfolio and resells shares of this portfolio to individual investors |
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mutual funds and transaction costs |
low for consumers |
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Pension |
a type of mutual fund that holds assets in order to provide retirement income to its members |
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Life insurance companies |
sells policies that guarantee a payment to a policy holder's benefits when a policy holder dies |
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bank deposit |
a claim on a bank that obliges the bank to give the depositor his or her cash when demanded |
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Bank |
financial intermediary that provides liquid assets in the form of bank deposits to lenders and uses the funds to finance the illiquid investment spending needs of borrowers |
