Egb Exam 2

Front 1

macroeconomic goals: economic growth

Back 1

- longterm
- increase in production of goods and services
- if real GDP increases faster than population, then country is wealthier (on a per-capita basis)

Front 2

macroeconomic goals: high employment/low unemployment

Back 2

- high unemployment means that the economy is not achieving its full economic potential
- unemployment rate: percentage of workforce that is looking for a job but hasn't found one
- unemployment rate lags general economy: unemployment usually peaks once we are out of a recession

Front 3

unemployment and business cycles

Back 3

business cycles: fluctuations in real GDP around its longterm growth trend

- expansion: increasing real GDP
-- output rises, firms hire more workers --> unemployment falls

- contraction: declining real GDP
-- output falls, firms lay off workers --> unemployment rises

Front 4

macroeconomic goals: stable prices

Back 4

- inflation rate: percentage increase in the average level of prices
- many governments target inflation rate at 2-3%

Front 5

gdp: definition

Back 5

total value of all final goods and services produced for the marketplace during a given period, within the nation's borders

Front 6

gdp: expenditure approach (the equation)

Back 6

gdp = c + i + g + nx

Front 7

gdp: C

Back 7

consumption spending
- largest component (70% of gdp)
- includes estimations for food (that is self-produced and consumed) and rent (in owner-occupied homes, how much they could have been rented for)
- excludes used goods, assets, new home construction (investment)

Front 8

gdp: I

Back 8

private investment
- includes business purchases of plant, equipment, and software; new home construction; changes in inventory stocks
- excludes government investment, consumer durables, human capital
- ignores depreciation

Front 9

gdp: G

Back 9

government purchases
- by federal, state, or local governments
- does not include transfer payments (money redistributed from one group of citizens to another)

Front 10

gdp: Xn

Back 10

- net exports = exports - imports
- to properly account for output sold to, and bought from, foreigners

Front 11

gdp: value-added approach

Back 11

the sum of the value added by all firms in the economy
- firm's revenue received for output minus cost of intermediate goods it buys

Front 12

gdp: factor payments approach

Back 12

sum of income earned by all households in the economy
- factor payments: wages/salaries, interest, rent, profit
- value added by a firm = total factor payments made by that firm
- total output of the economy is equal to the total income earned in the economy

Front 13

gdp: shortcomings

Back 13

does not record:
- quality changes (prices go down for same quality goods, like laptops)
- underground economy
- nonmarket production (no exchange of $, like two students tutoring each other)
- other aspects of economic well-being (quality of life improvements)

Front 14

unemployment: types

Back 14

frictional: people who are between jobs, entering labor market for first time or after an absence
- short-term

seasonal: related to changes in weather, tourist patterns
- short-term, predictable

structural: old, dying industries are replaced with new ones that require different skills/located in different areas of the country
- long-term

cyclical unemployment: changes in production over the business cycle

-

Front 15

unemployment: full employment

Back 15

zero cyclical unemployment

even at full employment, the overall unemployment rate is greater than zero

with full employment, economy reaches potential GDP

Front 16

unemployment: costs

Back 16

economic:
- opportunity cost of lost output (--> decreased consumption)

physical/psychological:
- burden of unemployment is not shared equally among different groups in population

Front 17

unemployment: measurement

Back 17

unemployed are willing and able to work, but are without jobs
unemployment rate = unemployed / labor force
- where labor force = people who have a job or are looking for one

Front 18

unemployment: measurement problems

Back 18

understates unemployment
- involuntary part-time workers as employed (even though they want to work full-time)
- discouraged workers as outside of labor force (even though they would like a job)

- employment rate is often a more useful measure

Front 19

gdp: effects of sudden disasters

Back 19

direct effects:
- destruction of nation's capital stock, disruption
- loss of output

Front 20

price level & CPI

Back 20

average level of prices in the economy

CPI: index of cost, through time, of a fixed market basket of goods purchased by a typical household in some base period
- (cost of market basket in current period / cost of market basket base period) x 100

Front 21

inflation rate

Back 21

measures how fast the price level is changing
- percentage change in the price level from one period to the next

long-term, prices of many goods have declined. but prices of goods in which labor is the largest input have not.

Front 22

CPI: how it's used

Back 22

as a policy target (price stability <--> low inflation)

to index payments (make up for loss in purchasing power caused by inflation)

to translate from nominal to real values

Front 23

gdp price index

Back 23

- index of price level for all final goods and services included in GDP
- measures the price of all goods and services that are included in GDP
- used to calculate real GDP

Front 24

inflation: costs

Back 24

if expected, inflation has less impact
but it can become built into future expectations (spiralling effect)

unexpected inflation shifts purchasing power from those awaiting future payments to those who are obligated to make future payments
- %change in real inflation = %change in nominal inflation - %change in price level

Front 25

CPI: bias (4)

Back 25

overstates inflation by ~1% each year, not retroactively corrected

- substitution bias
-- goods with rapidly rising prices - overweighted
-- goods with slowly rising prices - underweighted
-- only recognizes substitution within categories (steak for hamburger, but not fish for steak)

new technologies: excludes new products that tend to drop in price upon introduction to market; separates them from existing products (cable tv vs. movie theaters)

- does not fully account for changes in quality (overestimates how fast the price of a basket is rising)

- growth in discounting (lower prices at discounters) -- overstates inflation

Front 26

indexing social security

Back 26

with an upward-biased CPI (overstates inflation), real benefit payment continually increases, shifting purchasing power towards those who are indexed and away from the rest of society

Front 27

core CPI

Back 27

created by the Fed
excludes food and energy (prices more volatile than other components of CPI)

Front 28

the classical, long-run model

Back 28

the economy operates close to its potential output at full employment
- useful in explaining the long-run trend
- major assumption: markets clear (quantities supplied and demanded are equal)

Front 29

keynesian model

Back 29

help explain economic fluctuations (movements in GDP around its long-run trend)

Front 30

labor market: supply curve

Back 30

how many people want to work at various real wages
- upward sloping: as wage rate increases, more and more individuals are better off working than not working

Front 31

labor market: demand curve

Back 31

how many workers firms want to hire at various real wage rates
- downward sloping: as wage rates increase, firms find that they must employ fewer workers, in order to maximize profits

Front 32

labor market in the classical model

Back 32

economy achieves full employment on its own (markets clear)
- if wage rate > equilibrium wage rate, excess supply of labor
- if wage rate < equilibrium wage rate, excess demand for labor

Front 33

labor market in the keynesian model

Back 33

a change in supply or demand leads to a change in quantity (wages are sticky, take longer to adjust)
- so, we have labor shortages, or unemployment

Front 34

production function (and its slope)

Back 34

shows the total output the economy can produce with different quantities of labor, given fixed amounts of other resources and a fixed state of technology
- positive slope: more workers --> more output
- declining (but not negative!) slope: diminishing returns to labor (rise in output is smaller and smaller with each successive worker

Front 35

total spending (simple economy): say's law

Back 35

draw the diagram!

- say's law: in a simple economy with just households and firms, in which households spend all of their income on domestic output, total spending on output = total production during any given year
-- supply creates its own demand

Front 36

total spending (more realistic economy)

Back 36

- households save, pay taxes, and are not the only spenders
-- net taxes = total tax revenue - transfers
-- planned investment spending (business purchases of plant and equipment) = I - change in inventories

Front 37

disposable income --> household savings

Back 37

disposable income = total income - net taxes

household savings = disposable income - C

Front 38

total spending (realistic economy): leakages and injections

Back 38

- leakages: income earned, but not spent, by households (savings, taxes)
- injections: spending from sources other than households (Ip, G)

total spending = total output
- if and only if leakages = injections (S + T = Ip + G)

Front 39

loanable funds market: supply

Back 39

- household savings
- households receive interest payments on these funds
- supply of funds curve slopes upward (the higher the interest rate, the more households earn for the money they lend out)

Front 40

loanable funds market: deficits and surpluses

Back 40

deficit: when G > T
- deficit = G - T
- determines the government's demand for loanable funds (borrows money, pays interest on these funds)

surplus: when G < T
- surplus = T - G
- surplus can be invested or used to pay down existing debt

Front 41

loanable funds market: demand

Back 41

sum of business sector's planned investment (Ip) and the government sector's deficit, if any
- downward sloping: interest rate rises --> investment costs increase --> fewer projects will look attractive --> Ip will go down
- G is independent of the interest rate (vertical line)

Front 42

loanable funds market: say's law

Back 42

loanable funds market clears
- quantity of funds supplied = quantity of funds supplied
- S = Ip + (G - T)
- S + T = Ip + G
- Leakages = Injections
-- total spending = total output

Front 43

fiscal policy (definition)

Back 43

a change in government purchases or net taxes designed to change total output

Front 44

classical model: fiscal policy

Back 44

no demand-side effects (no change in spending)
- crowding out: if G increases, excess demand drives up the interest rate --> Ip decreases (money is more expensive to borrow), C decreases (money in savings earns more interest)

- draw the graph!

- cut in net taxes raises C, crowding out Ip
-- assumption: households spend the entire tax cut on consumption goods

Front 45

economic growth (basic definition)

Back 45

increases in the average standard of living
- if total output (real GDP) per person grows faster than population --> real GDP rises
-- if total output grows more slowly than the population --> average standard of living will fall

Front 46

rule of 72

Back 46

- 72 / rate of growth = years to double GDP

Front 47

cobb-douglas production function

Back 47

output = total factor productivity x capital x hours
- total factor productivity = A
- equipment, infrastructure = K
- hours = L = (population)(% of population working)(# of hours)

Front 48

production function: insight #1

Back 48

there is an optimal mix of workers and capital.
- capital and labor must grow in tandem

Front 49

production function: insight #2

Back 49

some initial growth for developing states comes from capital and education (human capital)

Front 50

production function: insight #3

Back 50

long-term growth comes from increases in total factor productivity (technology/innovation)
- PRODUCTIVITY IS THE MAIN SOURCE FOR WEALTH CREATION!

Front 51

government policies: increase employment and the EPR

Back 51

increase average hours (total hours/total employment) or increase employment-population ratio (epr) (total employment/population)

- increase labor supply: cut tax rates, cut benefits to the needy to shift labor supply rightward

- increase labor demand: increase skills of the workforce (human capital), subsidize employment, to shift demand curve rightward, raise output per person

Front 52

government policies: capital (and increasing it)

Back 52

all else equal, if K grows faster than L, then capital per worker increases, and labor productivity increases

increase capital through investment
- target businesses by reducing business taxes, granting specific investment incentives --> shift investment curve rightward
- target households by altering the tax system (decrease capital gains tax, switch to consumption tax, change transfer payments system) --> shift the savings curve rightward
- shrink the budget deficit or raise surplus to reduce interest rates --> increase investment

Front 53

government policies: increase human capital

Back 53

shift the production function upward, raise productivity, increase average standard of living

the faster the rate of technological change, the greater the growth rate of productivity
- rate of change depends on r&d spending

innovation encourages competition, forces companies to innovate faster

Front 54

fiscal policy: supply-side effects

Back 54

change in the quantity of resources available for production
- faster economic growth, higher living standards in future
- fewer consumer goods now

Front 55

economic fluctuations: boom

Back 55

period of time during which real GDP is above potential GDP

Front 56

economic fluctuations: why?

Back 56

production is planned long before goods are actually sold (inventories can build up/be depleted)

interdependence between production and income (people spend their income; firms receive revenue, used to hire workers and pay them income)

Front 57

economic fluctuations: recessions

Back 57

decrease in spending:
- production cutbacks --> firms lay off workers --> laid-off workers cut back their own spending --> firms in other sectors produce less...

Front 58

economic fluctuations: expansions

Back 58

higher spending --> greater production --> higher employment --> greater spending
- potential to overheat

Front 59

short-run macro model (basic definition)

Back 59

changes in spending affect real GDP in the short run

spending depends on income, income depends on spending

Front 60

consumption spending increases when..

Back 60

disposable income rises
- disposable income = income - net taxes = income - (taxes + transfers)

wealth rises
- total value of household assets less outstanding liabilities

interest rate falls
- the higher the interest rate, the greater the incentive to pay back debt, the less will be spent on consumption goods

Front 61

consumption function

Back 61

relationship between consumption and disposable income
- positively sloped
- vertical intercept: autonomous consumption spending
- slope: MPC (amount by which C increases when disposable income rises by $1)
-- = change in C/change in disposable income
-- 0 < MPC < 1

Front 62

consumption-income line

Back 62

aggregate consumption spending at each level of income or gdp
- slope = MPC
- if tax is fixed, line shifts down by (tax x MPC)

Front 63

consumption-income line: shifts

Back 63

movement along: change in income
- income ^ --> disposable income ^ --> C ^ --> movement rightward

shifts:
upward: net taxes decrease (transfers increase, taxes decrease), a increases (household wealth increases, interest rate decreases, greater optimism)
shift downward: net taxes increase (transfers decrease, taxes increase), a decreases (household wealth decreases, interest rate increases, greater pessimism)

Front 64

aggregate expenditure line

Back 64

C + I + G + Xn
- when income increases, AE increases
- change in AE = MPC x change in GDP

Front 65

equilibrium GDP in the short run

Back 65

output = AE

change in inventories = GDP - AE
AE < GDP --> chg in Inv > 0 --> GDP decreases
AE > GDP --> change in Inv < 0 --> GDP increases
AE = GDP --> chg in Inv = 0 --> no change in GDP

Front 66

45-degree line

Back 66

use to determine equilibrium real GDP

if AE line below the 45-degree line:
- AE< GDP
- inventories increase (by the distance between the two lines)
- GDP needs to go down

if AE line is above 45-dg line
- AE > GDP
- inventories decline (by the distance between the two lines)
- GDP needs to increase

Front 67

equilibrium GDP and employment

Back 67

at equilibrium GDP, not necessarily full employment GDP

less than full-employment GDP:
cyclical unemployment - low spending --> low production --> high unemployment

greater than full-employment GDP
high spending --> production exceeds potential output --> unemployment is unusually low

Front 68

equilibrium gdp: change in investment spending

Back 68

increase in investment spending --> sales revenue increases --> income/disposable income increases --> consumption spending increases

expenditure multiplier: measures change in equilibrium real GDP for every $1 change in C, Ip, G, Nx
- = 1/(1 - MPC)
- GDP increases (or falls) by more than the initial increase (or decrease) in investment spending

all of these increases in spending cause AE line to shift upward by the initial increase in spending
- so it intersects with the 45-dg line at a higher point, so gdp increases)

Front 69

countercyclical fiscal policy

Back 69

in the short-run, fiscal policy has demand- and supply-side effects
- governments use multiplier to determine how much money to inject

change G or T to reverse/prevent a recession or boom
- stimulate economy: increase G, decrease T
- slow down: decrease G, increase T
- change in GDP = multiplier x chg in GDP

Front 70

problems with counter-cyclical fiscal policy

Back 70

- timing delays, irreversibility
- fed may counteract fiscal policy
- politics


- value of multiplier is overstated (does not account for money used to pay taxes rather than passed on in C)

Front 71

money is

Back 71

a unit of value
a means of payment

Front 72

the money supply and prices

Back 72

money's value is determine by the size of the money supply and national wealth/production

P = Ms / Y
- Ms = money supply; Y = goods produced
- Y down, P up
- Ms up, P up

Front 73

measuring the money supply

Back 73

total amount of money held by public

measured based upon liquidity (ease of converting to cash)

Front 74

M1

Back 74

standard measure of the money stock
- includes cash in hands of public, demand deposits, other checkable deposits, travelers checks
-- growth in M1 largely due to growth in demand deposits

Front 75

M2

Back 75

M1 + savings-type accounts + retail MMMF + small-time deposits

Front 76

banks

Back 76

financial intermediaries - assemble loanable funds from households and firms whose revenues exceed their expenditures, channeling these funds to households and firms whose expenditures exceed revenues

private corporations owned by their stockholders

Front 77

bank's balance sheet

Back 77

net worth = total assets - total liabilities

assets: bonds (promises to pay back borrowed funds, issued by a corporation/government agency); loans (agreement to pay back borrowed funds, signed by a household or non-corporate business)

Front 78

banks: reserves

Back 78

required by law to hold reserves (sum of cash in vault and accounts with the Fed)
- required reserve ratio: minimum fraction of checking account balances that banks must hold as reserves (10% in US)

Front 79

The Fed

Back 79

central bank
12 district banks
not a part of any branch of government (created by Congress)
president and Congress appoint key officials

Front 80

functions of the Fed

Back 80

- controlling the money supply (affect availability of bank reserves by buying and selling securities with banks, which in turn influences lending and the money supply)
- issuing paper currency
- acting as a bank for banks
- supervising and regulating banks
- check clearing

Front 81

the Fed: tools to control the money supply: open market operations

Back 81

buy or sell government bonds to change the money supply
- assume households and businesses are satisfied holding the amount of money they are currently holding, banks never hold excess reserves (reserves in excess of required reserves)

- increase money supply: Fed will buy government bonds, injecting reserves/increasing money supply, banks lend out excess reserves --> demand deposits increase by demand deposit multiplier (1/RRR x chg in Reserves = chg in DD)

- decrease money supply by selling government bonds

Front 82

the Fed: tools to control the money supply: 2 more

Back 82

changes in the required reserve ratio
- RRR decreases, money supply increases

changes in the discount rate
- lower discount rate enables banks to borrow reserves from the Fed more cheaply, encouraging banks to borrow more -- money supply increases

Front 83

the federal funds rate

Back 83

the rate banks charge each other to borrow money

Front 84

bank failures and banking panics

Back 84

a bank fails when assets < liabilities, so net worth < 0

run on the bank: attempt by many of a bank's depositors to withdraw their funds (liquidity crisis)

banking panic: simultaneous runs, highly disruptive to economy
- deposit insurance (FDIC) removes risk of bank run

Front 85

demand for money

Back 85

how much money people would like to hold, given the constraints they face (wealth is given, give up one kind of wealth in order to acquire another)

opportunity cost: when you hold money, you give up the interest that money could be earning

two assets: money (means of payment, but no interest); bonds (earns interest, but not means of payment)

Front 86

demand for money, price level, income, interest rate

Back 86

price level high, dollar cost of purchases high, money to hold high

real income high, purchasing power high, money to hold high

interest rate high, opportunity cost of holding money high, money to hold low

Front 87

economy-wide demand for money

Back 87

amount of total wealth in the economy that all households and businesses, together, choose to hold as money rather than bonds
- rise in price level, real income --> demand increases
- rise in interest rate --> demand decreases

Front 88

money demand curve

Back 88

shows the total quantity of money demanded at each interest rate
- downward sloping: drop in interest rate lowers the opportunity cost of holding money, increases quantity demanded

Front 89

money demand curve: movement and shifts

Back 89

movement along
- change in the interest rate

shift
- change in money demand caused by something other than the interest rate (real income, price level)

Front 90

supply of money

Back 90

controlled by Fed
independent of interest rate

money supply curve (quantity of money in economy at each interest rate) is vertical line

Front 91

shifts of money supply curve

Back 91

right:
open market purchases
inject reserves into banking system

left:
open market sales
withdraw reserves

Front 92

money market equilibrium

Back 92

quantity of money people are actually holding (Qs) is equal to the quantity of money they want to hold (Qd)

interest rate higher than equilibrium --> excess supply of money --> excess demand for bonds --> price of bonds increases --> interest rate decreases

interest rate lower than equilibrium --> excess demand for money --> excess supply of bonds --> price of bonds decreases --> interest rate increases

Front 93

changing the interest rate

Back 93

fed conducts open market purchases --> money supply --> excess supply of money and excess demand for bonds --> price of bonds --> interest rate decreases

fed conducts open market sales --> money supply decreases --> excess demand for money and excess supply of bonds --> price of bonds decreases --> interest rate increases

Front 94

what spending increases when the fed conducts open market purchases

Back 94

open market purchases --> money supply increases --> interest rate falls

spending on plant and equipment, new housing, consumer durables increases

Front 95

monetary policy

Back 95

control or manipulation of money supply by the Fed to achieve a macro goal

open market purchases --> money supply increases --> interest rate decreases --> a and Ip increase --(multiplier effect)--> real GDP increases

open market sales --> money supply decreases --> interest rate increases --> a and Ip decrease --(multiplier effect)--> real GDP decreases

Front 96

monetary policy and the federal funds rate

Back 96

the Fed adjusts the money supply to maintain or change the target federal funds rate, to prevent fluctuations in money demand from affecting the economy

Front 97

interest rate theories: short run and long run

Back 97

short run:
money market
wealth holders: money and bonds
the Fed controls the money supply

long run:
market for loanable funds
household savings lent to businesses and government

Front 98

aggregate supply

Back 98

short term: elastic
- so, changes in aggregate demand lead to changes in prices and changes in output

long run: inelastic
- so, changes in AD lead to changes in prices but do not effect output

increases due to technology and new resources --> potential real GDP grows

Front 99

G leads to a crowding out effect on I when..

Back 99

government runs a deficit

Front 100

AD curve

Back 100

shows equilibrium GDP at each price level

deriving the curve:
rise in price level --> Md shifts rightward --> higher interest rate --> AE shifts downward --> decrease in equilibrium GDP

Front 101

AD curve: movements along

Back 101

price level increases --> Md increases --> interest rate increases --> a, Ip decrease --> equilibrium real GDP decreases

price level decreases --> Md decreases --> interest rate decreases --> a, Ip increase --> equilibrium real GDP increases

Front 102

AD curve: shifts

Back 102

shift rightward with
increase in
- G, I, a, Xn, Ms
decrease in
- net Taxes

Front 103

what factors help explain the low growth rate of many less developed countries

Back 103

high population growth
poor infrastructure
broken legal systems/other institutions
inability to invest in capital stock given poverty

Front 104

AS curve: gdp and the price level

Back 104

in the short run:

rise in real GDP
- unit costs, price level increases

fall in real GDP
- unit costs, price level decreases

Front 105

AS curve: deriving

Back 105

aggregate supply curve indicates the price level consistent with unit costs and their percentage markups at any level of output over the short run

Front 106

AS curve: movements along

Back 106

changes in price level

real GDP increases --> input requirements per unit of output, prices of nonlabor inputs increase --> unit costs increase --> price level increases

real gdp decreases --> input requirements per unit of output, prices of nonlabor inputs decrease --> unit costs decrease --> price level decreases

Front 107

AS curve: shifts

Back 107

changes in world oil prices, weather, technology, nominal wage

upward if unit costs increase for any reason other than an increase in real GDP
downward if unit costs decrease for any reason besides an increase in real GDP

Front 108

the tax multiplier

Back 108

tax cuts have a less stimulative effect on AE than do other forms of monetary policy

Front 109

what makes the federal reserve independent? why is it independent?

Back 109

members have long terms, cannot be fired by the president
decisions on interest rates are made by members at many levels (FOMC, Board of Governors, regional Fed banks - appointed by local banks)

independent because it must make politically unpopular decisions