Macro February 23

Front 1

aggregate expenditure (AE)

Back 1

the total amount of domestically produced goods and services bought by the four major purchasers in the economy

Front 2

4 major purchasers in the economy

Back 2

1. consumers (70%)
2. businesses (13%)
3. government (20%)
4. foreign consumers

Front 3

current disposable income

Back 3

total current income (GDP) after taxes are taken out after transfer payments are added
= YD
= Y-T + TR
where T=Total taxes
TR= Transfer payments

Front 4

determinants of consumption

Back 4

1. current disposable income
2. expected future disposable income
3. real interest rate (r)
4. household wealth
5. Price Level (P)

Front 5

consumption function

Back 5

relationship between consumption spending and disposable income

Front 6

marginal propensity to consume (MPC)

Back 6

the slope of the consumption function: the amount by which consumption spending changes when disposable income changes
MPC = (Change in C)/(change in disposable income)

Front 7

when the real interest rate (r) goes up, consumption (c) goes down BECAUSE:

Back 7

a) it costs more to borrow to finance consumption
b) there is more incentive to save

Front 8

when real interest rate (r) goes up, consumption (c) goes down BECAUSE:

Back 8

a) it costs less to borrow to finance consumption
b) there is less incentive to save

Front 9

household assets

Back 9

value of home, car, financial investments (checking and savings accounts, stocks, bonds)

Front 10

household liabilities

Back 10

credit card debt, balance due on mortgage, balance due on auto loan

Front 11

when household wealth (w) goes up, what happens to consumption (c)?

Back 11

wealth goes up, consumption goes up

Front 12

when household wealth (w) goes down, what happens to consumption (c)?

Back 12

when household wealth goes down, consumption goes down

Front 13

when the price level (P) goes up, what happens to household wealth (w) and consumption (c)?

Back 13

when price level goes up, wealth goes down, and consumption goes down

Front 14

when the price level (P) goes down, what happens to household wealth (w) and consumption (c)?

Back 14

when price level goes down, wealth goes up, and consumption goes up

Front 15

what is investment (I)?

Back 15

1. plant and equipment (77%)
2. housing (19%)
3. inventories (3%)
-finished gods not yet sold
-raw material not yet used
-unfinished goods still in the
production process

Front 16

determinants of Investment

Back 16

1. expectations of future profitability (optimism or pesimism)
2. taxes (corporate income tax, investment tax incentives)
3. cash flow
4. interest rate

Front 17

Where do companies get the funds for investment?

Back 17

Savings--> Financial Capital (savings accounts, stocks, bonds, etc.)-->physical capital

Front 18

financing alternatives

Back 18

1. retained profits (plowback) -75%
2. bank loans--15%
3. bonds-7.5%
4. stocks-2.5%

Front 19

internal funds

Back 19

retained profits (plowback)

Front 20

securities

Back 20

bonds and stocks

Front 21

external funds

Back 21

bank loans, bonds, stocks

Front 22

primary markets

Back 22

where securities are first sold to the public, and where firms or governments receive the bulk of the revenue from those sales

Front 23

secondary markets

Back 23

where individual and institutional investors trade securities among themselves

Front 24

do issuers of securities recieve any proceeds from transactions in the secondary market?

Back 24

NO

Front 25

what are bonds?

Back 25

a way to borrow money; they acknowledge a debt; they are IOUs

Front 26

who issues bonds

Back 26

1. corporations
2. governments (federal, states, cities, foreign governments)

Front 27

risks relating to bonds

Back 27

1. credit risk
2. interest rate risk

Front 28

"i", or the interest, or discount rate occurs when we know:

Back 28

"i" , and solve for Price Bond

Front 29

"i", is called the "yield" when we know:

Back 29

Bond Price and solve for "i"

Front 30

Difference between stocks and bonds

Back 30

bonds are IOU and stock are an ownership share. Bonds have a coupon payment, stocks have dividend. Bonds are in position in event of liquidation and stocks are residual claimant

Front 31

nominal exchange rate (E)

Back 31

price of one currency in terms of another currency; how many units of another currency can I buy with one unit of the local currency.

Front 32

What does it mean if E changes from E=2 to E=3

Back 32

-now with one dollar I can get more euros
-$ is more valuable (has appreciated with respect to the euro)
-euro is cheaper (has depreciated with respect to the dollar)

Front 33

what affects the nominal exchange rate (E)?

Back 33

1. speculation
2. changes in expectations (if an economy is going to do good, people buy assets there, so demand for currency goes up---> price of currency increases)
3. r (real interest rate)

Front 34

how does r(foreign) affect E(U.S.):?

Back 34

since r affects consumption decisions, it also affects savings:
-r(U.S.) increases= people save more US
-Demand for $ increases
-price of $ increases-->$ appreciates (more expensive)
-E increases (with $1 we can buy more euros

Front 35

arbitrage

Back 35

-capacity of making profits out of differences in prices in 2 or more markets
-in the example with watches, watches are cheaper in Europe (arbitrage possibility)

Front 36

what happens when there is arbitrage possibility?

Back 36

-EVERYONE wants to do the same (buy EU, sell watches in the U.S.)
-therefore, the DEMAND for watches in EU skyrockets--> prices in EU increase

Front 37

Purchasing Power Parody (PPP)

Back 37

E should be such that e=1
-since e=1, E=(Pfor.)/(Pdom.)
PPP implies that the nominal exchange rate b/w 2 countries should equal the ratio of price levels.

Front 38

1. If E is at the PPP level, what does e equal?
2. if e>1, then E is___?

Back 38

1. e=1
2. then E is too high, i.e. the foreign currency is UNDERVALUED relative to the domestic currency
**the greater a country's inflation rate, the faster its currency should depreciate

Front 39

limitations of the PPP Theory: 2 reasons why exchange rates don't always adjust to equalize prices across countries:

Back 39

-many goods can't easily be traded ex: haircuts, movies
-price differences on such goods can't be arbitraged away

Front 40

real exchange rate

Back 40

the price of goods in one country in terms of the price of goods in some other country

Front 41

one of the most important determinants of E's fluctuation:

Back 41

r! (real interest rate)

Front 42

why can r cause E to fluctuate?

Back 42

if r(U.S.) goes up relative to r in ROW:
--demand for $-denominated assets go up
--demand for $ goes up
--price of dollar goes up
--therefore E goes up

Front 43

real v. nominal exchange rate

Back 43

nominal exchange rate: is the # of units of foreign currency per unit of domestic currency
real exchange rate: the number of units of foreign goods per unit of domestic good