Econ Unit 2 Key Terms

Front 1

UFE

Back 1

full employment rate of unemployment

Front 2

What influences UFE?

Back 2

Demographics (i.e. age structure of labor force)

Front 3

Inflation

Back 3

a long-run, continuous increase in price level

Front 4

What causes inflation?

Back 4

1. Demand pull -- rightward shift of Aggregate Demand
(more common)

2. Cost Push -- leftwards shift of Aggregate Supply

Front 5

% Change in Aggregrate Demand = ?

Back 5

% change in price (inflation rate) + % change in Real GDP (Y; output growth)

Front 6

When does inflation occur?

Back 6

When demand grows faster than output

Front 7

What is Aggregate Supply growth constrained by?

Back 7

1. growth of technology
2. growth of the factors of production

Front 8

What is the long-run growth of Y?

Back 8

~3% per year

Front 9

What constrains Aggregate Demand growth?

Back 9

Nothing; money creation is unlimited

Front 10

What is the result of the Federal Reserve printing money?

Back 10

The Federal Reserve prints too much money, and this causes Aggregate Demand to grow faster than output. They do this because rising prices are better than falling prices (burden of debt)

Front 11

What are the effects of inflation?

Back 11

1. Reduces the real purchasing power of those on fixed nominal incomes

2. Changes relative prices

3. Raises tax rates if the tax system is progressive and not indexed to inflation

4. Raises interest rates

Front 12

Fixed Nominal Income & it's relation to inflation

Back 12

Someone who is collecting a fixed annuity (when you're paid a fixed dollar amount each month until debt i.e. life insurance/non-compounded interest)

If inflation kicks in, the purchasing power of your monethy check decreases

Front 13

Bracket creep

Back 13

Inflation leads to an increase in nominal income, which pushes earners into a higher tax bracket

Therefore, you are paying a higher tax rate, but your pre-tax income isn't worth anymore because prices are increasing along with your income

Front 14

Fisher's equation of interest rates - define variables

Back 14

r = nominal interest rate (the interest rate we observe)
i = real interest rate (how much money we actually earn in interest after inflation, taxes, etc.)
p^e = expected inflation rate
p = actual inflation rate

Front 15

If p^e = 3%/year, what does that mean for someone who has assets of $100?

Back 15

What their $100 can buy today will require $103 one year from today.

Front 16

Fisher's equation (ex ante)

Back 16

i = r - p^e

Front 17

Fisher's equation (ex post)

Back 17

i = r - p

Front 18

Ex Ante

Back 18

expected return; "looking forward"

Front 19

Ex Post

Back 19

actual return; "looking backward"

Front 20

p (p-dot)

Back 20

Actual Inflation

Front 21

What are the three possible scenarios when evaluating a return with Fisher's equations?

Back 21

1. p = p^e (correct expectations; no unexpected wealth transfers)

2. p > p^e (underestimated inflation; Borrower/Bank wins, and Lender loses)

3. p < p^e (overestimated inflation; Lender wins and Bank/Borrower loses)

Front 22

Ex ante after tax real return for nominal interest income (equation)

Back 22

= r (1 - t) - p^e

Front 23

Ex post after tax real return for nominal interest income (equation)

Back 23

= r (1 - t) - p

Front 24

What do both ex ante and ex post after tax real return equations assume?

Back 24

Both equatoins assume that tax is applied to nominal interest income (not income adjusted for inflation (?))

Front 25

Ex ante after tax real return for real interest income (equation)

Back 25

= (r - p^e) (1 - t)

Front 26

Ex post after tax real return for real interest income (equation)

Back 26

= (r - p) (1 - t)

Front 27

What is the difference between paying taxes on your nominal versus real interest income

Back 27

Nominal interest income means you are paying taxes on inflation; With real interest income, you aren't paying taxes on inflation--the inflation rate is subtracted from the interest rate before multiplying the tax rate)

Front 28

Fisher Effect

Back 28

Change in r = Chage in p in long run

(assuming that i is approximately constant in the equation < r = i + p^e >)

Front 29

In the long run, what is the relationship between the change in the actual inflation rate and the change in the expected inflation rate?

Back 29

In the long run, all inflation is correctly expected; the rate of change in actual and expected inflation is the same

Front 30

What does the Fisher Effect tell us about countries that have the highest interest rate?

Back 30

They have the highest inflation rate

Front 31

How much of the GDP does consumption spending constitute?

Back 31

~65%

Front 32

What factors influence consumption spending?

Back 32

Y = Income = real GDP
T = Taxes
P = Price level
CO = Consumer Optimism
W = Wealth
r = interest rate = cost of borrowing/return on savings

Front 33

What is the relationship between Y^d and C?

Back 33

positive relationship (Y^d = disposable income); as disposable income increases, so does consumption spending

Front 34

The variable "a"

Back 34

autonomous consumption spending

C = a if Y^d = 0

it's the amount of money we spend with 0 disposable income through borrowing or dissaving

Front 35

MPC

Back 35

Marginal Propensity to Consume = variable "b"

--> the increase in C if Y^d (disposable income) increases by $1

= (the change in C) / (the change in Y^d)

Front 36

The variable "a"

Back 36

autonomous consumption spending

C = a if Y^d = 0

it's the amount of money we spend with 0 disposable income through borrowing or dissaving

Front 37

Savings equation

Back 37

S = -a + (1 - b) Y^d

Front 38

MPC

Back 38

Marginal Propensity to Consume = variable "b"

--> the increase in C if Y^d (disposable income) increases by $1

= (the change in C) / (the change in Y^d)

Front 39

Savings equation

Back 39

S = -a + (1 - b) Y^d

Front 40

MPS

Back 40

Marginal Propensity to Save = 1 - b = 1 - MPC

Front 41

MPS

Back 41

Marginal Propensity to Save = 1 - b = 1 - MPC

Front 42

APC

Back 42

Average Propensity to Consume

= (C / Y^d) x 100% = % of Y^d spent on C

= (S / Y^d) x 100% = % of Y^d saved

(APC + APS = 100%)

Front 43

APC

Back 43

Average Propensity to Consume

= (C / Y^d) x 100% = % of Y^d spent on C

= (S / Y^d) x 100% = % of Y^d saved

(APC + APS = 100%)

Front 44

What happens to APC as Y^d (disposable income) increases?

Back 44

As Y^d increases, APC decreases

-->As income increases, you save a larger proportion of the money; therefore, APS rises with Y^d

Front 45

What happens to APC as Y^d (disposable income) increases?

Back 45

As Y^d increases, APC decreases

-->As income increases, you save a larger proportion of the money; therefore, APS rises with Y^d

Front 46

What did Simon Kuznets do?

Back 46

He confirmed the Keynesian consumption function that suggested as Y^d increases, APC decrease and APS increases

Front 47

What did Simon Kuznets do?

Back 47

He confirmed the Keynesian consumption function that suggested as Y^d increases, APC decrease and APS increases

Front 48

What happens to APC and APS in the short run and long run as income rises?**

Back 48

short run:
APC decreases; APS increases

long run:
APC increases and APS decreases
(you realize that the increase in income is permanent, so you spend more and save less

Front 49

How much of the GDP does consumption spending constitute?

Back 49

~65%

Front 50

What happens to APC and APS in the short run and long run as income rises?**

Back 50

short run:
APC decreases; APS increases

long run:
APC increases and APS decreases
(you realize that the increase in income is permanent, so you spend more and save less

Front 51

What is the relationship between C and Y^d

Back 51

positive

Front 52

What factors influence consumption spending?

Back 52

Y = Income = real GDP
T = Taxes
P = Price level
CO = Consumer Optimism
W = Wealth
r = interest rate = cost of borrowing/return on savings

Front 53

What is the relationship between C and Y^d

Back 53

positive

Front 54

What is the relationship between C and P

Back 54

negative

Front 55

What is the relationship between C and P

Back 55

negative

Front 56

What is the relationship between Y^d and C?

Back 56

positive relationship (Y^d = disposable income); as disposable income increases, so does consumption spending

Front 57

What is the relationship between C and CO

Back 57

positive

Front 58

What is the relationship between C and W

Back 58

positive

Front 59

What is the relationship between C and r

Back 59

negative

Front 60

I

Back 60

I = Investment (new plant, equipment, residential structures, etc; this spending is done by firms)

I = f (r, e)

e = expected profit on new investment projects
r = interest rates

Front 61

ROR

Back 61

expected rate of return on a new investment project

= [ (annual expected profit on investment projects (e)) / (cost of the asset) ] x 100%

Front 62

An investment is profitable to a company up until what point?

Back 62

An investment is no longer profitable if the ROR is < the interest rate

Front 63

What is the relationship between r & I?

Back 63

negative; as r increases, I decreses

Front 64

What is the relationship between e & I?

Back 64

positive; if you expect to ear more on investments, you invest more

Front 65

Why is investment so unstable?

Back 65

1. Because e is unstable--> entrepreneurs are subject to "animal spirits" (i.e. optimism and pessimism)

2. Investment goods are durable (therefore, during a recession, there is excess capacity and thus no need to buy more)

3. Investment goods are irreversiable (they are only good for one service)

Front 66

What happens to Net Exports as the cost of US goods decreases?

Back 66

Net Exports increase.

(P^us/P^f) = Prices in US relative to prices in foreign countries; as P^us decreases, this ratio decreases as well, making US goods become more attractive relative to foreign goods

Front 67

Why does AD slope down?

Back 67

1. Because a decrease in Price leads to an increase in C (& an increase in real money holdings) (& as C goes up, Y goes up;

2. A decrease in P leads to a decrease in (P^us/P^f) which leads to an increase in Net X


therefore, as P goes down, Y goes up

Front 68

What shifts AD?

Back 68

1. A change in taxes (negative)
2. CO (positive)
3. W (positive)
4. e (expected investment profit) (positive)
5. G (positive)
6. $/f (exchange rate) (positive)
---> $/f is the exchange rate; if this decreases, this means the US dollar is depreciating, which will lead to an increase in Net X; this in turn will result in an increase in AD (.-. positive)

Front 69

Production function

Back 69

Y = (A) f(K, L)

Front 70

L

Back 70

Number of hours worked

Front 71

Real wage

Back 71

(nominal wage) / (price level)

= $ / hour
(inflation adjusted wage rate)

Front 72

Why does L^d slope down?

Back 72

As the number of hours worked increases, the increase in output increases at a decreasing rate (law of diminishing returns)

--it becomes decreasingly profitable to higher workers (marginal stuff)

Front 73

What shifts L^d?

Back 73

A change in technology or capital stock (which are otherwise presumed to be held constant)

Front 74

L^s

Back 74

Labor supply; how many hours do households want to work?

Front 75

What shifts L^s?

Back 75

1. Demographics
2. Tax rates on labor income

Front 76

What is the relationship between L^s and tax rates on labor income?

Back 76

negative

if income tax decreases, after tax real wages incresae, leading to an increase in the number of hours people want to work (L^s)

Front 77

L^d

Back 77

Labor demand; how many hours firms want to employ @ various real wages (it's a graphed schedule of this)

Front 78

GRAPH:

Labor Market Analysis: show what happens on the plot of L^s and L^d if the population experiences the Bubonic Plague

Back 78

Increase in the real wage rate, and a decrease in L (# of hours worked)

Front 79

GRAPH:

Labor Market Analysis: show what happens on the plot of L^s and L^d if there is an increase in immigration

Back 79

Wage rate falls (because there are more people willing to work at previous wage rate) and L (number of hours worked) increases

Front 80

GRAPH:

Labor Market Analysis: show what happens on the plot of L^s and L^d if there is an increase in technology

Back 80

the real wage rate and L (number of hours worked) both increase

Front 81

When does involuntary unemployment occur?

Back 81

When L^s < L^d

How many are working < How many want to work

Front 82

What causes involuntary unemployment?

Back 82

A set wage rate that is above the equilibrium wage rate (typically set by labor unions)

see page 9 1/2 of notes

Front 83

How are wages in the short and long run?

Back 83

Fixed in the short run because of labor contracts, but flexible in the long run because contracts are negotiable

Front 84

Why does SRAS slope up?

Back 84

an increase in price leads to a decrease in real wages (because nominal wages are fixed in the short run). This leads to an increase in L (# of hours worked), which leads to an increase in Y

Therefore, increase in P --> increase in Y
(upward slope)

Front 85

What shifts SRAS?

Back 85

1. change in input costs (negative)
2. change in technology (positive)
3. change in capital stock (positive)
4. change in equilibrium employment (L) caused by a change in L^d or L^s (positive)

Front 86

Why is LRAS vertical?

Back 86

Because in the long-run, all prices (including wages) are flexible

L^s = L^d in long run
--> L = L^FE
--> Y = Y^FE

Front 87

What shifts LRAS?

Back 87

1. a change in technology
2. a change in capital stock
3. a change in L (number of hours worked) caused by a change in L^s or L^d

(all positive relationships)

Front 88

Contractionary Gap and it's effect on SRAS

Back 88

When Y < Y^FE

"labor surplus"; leads to a decrease in nominal wages (input cost) and a rightward shift of SRAS

Front 89

Transitory Beneficial Supply Shock

Back 89

Temporary increase in output and temprorary decrease in price

i.e. good growing conditions

Front 90

Transitory Adverse Supply Shock

Back 90

Temporary decrease in output and temporary increase in price

i.e. a drought

Front 91

Permanent Beneficial Supply Shock

Back 91

permanent increase in output and permanent decrease in price

i.e. increase in technology

Front 92

What causes a permanent beneficial supply shock?

Back 92

1. change in technology
2. change in capital stock
3. change in labor supply (permanent; i.e. immigration)

Front 93

Permanent Adverse Supply Shock

Back 93

Permanent increase in price and permanent decrease in output

i.e. new government regulation that blocks technology; war; emigration (people leave)

Front 94

Hysteresis

Back 94

"follow behind" (?)

Front 95

Fiscal Policy

Back 95

changes in G and/or taxes to stabilize economy

Front 96

Contractionary Gap

Back 96

Y < Y^FE

Front 97

What are the primary considerations on taking money as bonds and loaning that money regarding how effective this will stimulate the economy?

Back 97

1. What did the original lender plan to do with the money? (spend/save)

2. What does the recipient plan to do with the money?

3. Will taxes have to be raised to pay off new debt? (if future tax increases are expected, save today and decrease spending) to pay for future taxes

4. What exactly does government spend funds on?

5. Who are you borrowing from? (domestic/foreign)

Front 98

What are the three automatic stabilizers?

Back 98

1. Graduated Income Tax (progressive) (increase in Y increases tax rates)
2. Welfare System (increase in Y decreases outlays on welfare)
3. Unemployment Compensation (increase in Y decreases unemployment which decreases outlaws on unemployment comp)

Front 99

Automatic Stabilizers (def)

Back 99

Fiscal changes that automatically take place and help stabilize spending

Front 100

Discretionary Fiscal Policy

Back 100

deliberate changes in G and/or taxes to alter AD

i.e. stiumuls spending and tax changes

Front 101

What are the two problems with discretionary fiscal policy?

Back 101

1. Temporary tax changes don't alter spending

2. Policy Lags

Front 102

Views on discretionary fiscal policy - timeline

Back 102

Pre 1930's: Leave it Alone

1930's-late 1970s: Proactive (use policy)

1980's: Use fiscal policy to promote long-run growth--"Supply-Side Economics"

Front 103

Laffer Curve

Back 103

states that there is a tax rate that will maximize tax revenue

see page 4 1/2 of notes

Front 104

How did Arthur Laffer reason that a decrease in the tax rate may increase tax revenue?

Back 104

1. A decrease in tax rates leads to an increase in after tax real wages which leads to an increase in labor supply, which leads to an increase in Y, which provides more income to tax

2. A decrease in the tax rate increases after tax income, which increases C & S. With an increase of S, there is an increase in I and K, which leads to more output in the future (increase in Y)-->more income to tax

3. A decrease in the tax rate increases taxable economic activity and a decrease in activity designed to avoid taxes (i.e. bartering/working under the table)

Front 105

Budget Deficit

Back 105

= Outlays - Revenue

Front 106

Tax Revenue =

Back 106

= (average tax rate on income) (income)

= (t) (Y)

Therefore, because the % change in Y is about 3% per year , it well take a long time for a decrease in tax rates to raise tax revenue