g-t > 0
cutting taxes ...
what two things do you need to know to get the economy back to y*?
What is the "true tax" and why?
"g" .. one reason is because if our dollars buy less than we are being taxed
what is the money supply made up of?
what if nobody deposited their money in the bank?
the money multiplier would be 0 (1/0)
T/F: An rd of 8% makes the banks pay 8% interest overnight, so if a bank borrows $100 then they pay $8 interest that night.
FALSE. The bank would pay 8% annual interest calcluated for the time that it borrowed the money. (the rd is annualized) obviously
T/F if the government increases G by $1B and decrease T by $1B AD will increase
TRUE. the balanced budget multiplier is 1; but AD will still increase because the change in G has a greater effect on
does who the gov't collects taxes from determine who pays a tax?
NO! Elasticity of demand determines who pays a tax. Inelastic goods = demanders pay. Elastic goods = suppliers pay.
Does who the government collects taxes from matter ? (in terms of the outcome p & y) ?
NO! the outcome is the same, however either demanders or suppliers will shoulder the tax based on elasticity of demand.
Is taxing monopolies a good public policy to increase output?
NO! Never tax monopolies. The correct public policy is to subsidize monopolists.
What should be the goal of Macroeconomic policy?
Keep inflation under control and supress/stimulate AD in order to reduce fluctuations of output
If inflation redistributes wealth, who is likely to gain? Debtors? or Crediters?
DEBTORS. If you owe $100 to the bank and then a year later inflation makes that nominal $100 that you owe worth $50 REAL dollars then YOU, a debtor, WIN!
why can money measure economic activity?
Because almost all economic transactions occur in terms of $.
Is GDP overstated or understated?
UNDERSTATED. If I mow my lawn it is not counted in GDP. Likewise, if I sell my car illegaly it is not counted in GDP.
Is Inflation (as stated in the USA by the CPI) Overstated or Understated?
OVERSTATED. 300 million americans have cell phones but that isn't even in the CPI. Also, some goods in the CPI are not the same goods- ie TVs in 1982 are not the same TVs in 2012
Is Unemployment Overstated or Understated?
UNDERSTATED. The main reason for this is because of the "discouraged worker" problem. Many leave the "work force" because they are discouraged, however they are still unemployed, but not by the "unemployment" measure.
Does GDP per capita overstate or understate INDIVIDUAL WELL BEING?
OVERSTATES. If you have 100 people in an economy and on of them is Bill gates and the other 99 make $1 a year, if you divide (bill gates wealth + 99*$1)/(100 people) it will appear that everyone is very well off. GDP per capita does not take into account distribution of income and inequality.
What problems do comparisons of an economy's aggregate output (GDP) create over time?
GDP may increase just because of price changes.
can nominal GDP go up while real GDP falls?
yes. if output really decreases, but prices increase enough. nominal GDP could increase while real GDP falls
What are national income accounts?
12. National Income Accounts is a system of accounts through which the government provides estimates of personal income available to US citizens (pp. 338-341).
Why is there a difference between disposable income and GDP?
GDP includes taxes, and the like, whereas disposable income is your income after you've already paid your taxes.
What is Aggregate Quantity Supplied?
The amount of output supplied AT A PARTICULAR PRICE LEVEL
What is Aggregate Supply
The amount supplied at ANY price level.
What will happen if AD decreases and P does not changes?
A recession will follow.
What determines full employment?
the real wage.
Does an economy automatically shift to full employment?
Yes. if W/P is too high then there is an excess supply, which will put downward pressure on the price. If W/P is too low there will be excess demand which will drive up the price!
Can real output fall when there is inflation?
YES. When there is an adverse aggergate supply shock. (the opposite is true for a positive AS shock)
Do changes in the price level do not affect real output?
NO! A change in the price level does NOT affect real output! REAL OUTPUT = ASLR
When AD falls, does the real wage increase or decrease?
When AD falls (adverse AD shock) the real wage INCREASES. Real wage = W/P -or- The amount you're paid divided by the price level (CPI). When the CPI falls and the amount you're being paid (nominal wage) stays the same- your REAL wage increases.
When nominal wage goes up what happens to ASSR?
Shifts to the left (inward), because firms don't want to pay employees more so they employ less of them.
Does investment add to the instability of aggregate demand?
Yes. Because firms will change their expectations based on fluctuations in AD, and thus i will either increase or decrease based on the firms' expectations.
When is aggregate demand equal to potential real output (full employment/ASLR)? (hint: think of desired savings)
ONLY WHEN desired savings = desired investment
The generalization that any 1-percentage-point rise in the unemployment rate above the full-employment unemployment rate will increase the GDP gap by 2 percent of the potential output (GDP) of the economy.
what is the correct fiscal policy when there is inflation?
TAX! DECREASE GOV'T EXPENDITURES (less g). to suppress AD.
Can a fiscal policy increase AD and simultaneously decrease AS?
YES. war in iraq would increase AD and suppress AS and output (lives lost due to the war, etc). GDP is increased in the short run, but we incur the cost of a lower GDP in the future
Is there a difference between the amount that the Gov't spends on goods and services and "government purchases" ?
Yes. Is the money that the gov't spends on welfare a good or service? No. The Gov't redistributes wealth and this is neither a good nor a service.
If the gov't increases "G" does that mean that the gov't is actively getting larger?
NO. Fiscal policy sometimes requires to increase "g" and sometimes requires to suppress "g". An active fiscal policy does not indicate that the gov't is increasing or decreasing in size. (contrary to popular opinion)
Do supply-side policies cause inflation?
NO. policies that are designed to increase AS will increase output without causing inflation.
Is the "G" multiplier relevant to "government transfer payments" ?
NO. The G multiplier is only relavant to "g" expenditures that are not transfer payments.
If the fed reduces the rd, does that mean FOR CERTAIN that the money supply will increase?
fractional reserve banking
when banks hold only a fraction of their demand deposits as reserves.
what is more liquid, M1 or M2?
M1! M1= checking, cash, and other liquid forms of currency, M2= short term bonds, and other less liquid holdings.
Is the discount rate less than, equal to, or greater than the Federal funds rate? Explain why.
the rd is always LESS THAN the FFR. This is because banks prefer to borrow money from each other as opposed to the FED.
When is an economy in "full employment" ?
If every worker that wants to work at the market wage is able to get a job at that wage, we say the economy is in full employment.
why might frictional unemployment have increased over the last two decades?
people are becoming more specialized and thus it takes more time to find a job when you're very specialized.
Does the unemployment measure take into account if someone is a head of household or not?
No. It treats punk 18 year old college kids the same as 41 year old single working moms.
why do workers prefer to be laid off than to receiving a wage cut?
because workers can not tell if AD has truly decreased and they observe that employers lose nothing when their wage is cut, thus they are very suspicious of such activity and prefer to be laid off.
Does inflation shift AD?
NO! Only CHANGES IN EXPECTED INFLATION.
As long as expectations about inflation are consistent with the actual inflation, the economy should have full employment and produce at its potential even though the price level is increasing.
As long as expectations of inflation and inflation remain the same, an economy should be at full employment. T/F
What has to happen to the price level in order for the economy to produce more than expected?
The price level must continually ACCELERATE. Accelerate means to increase more than the expected increase
When prices rise due to an increase in the cost of production. (adverse AS shocks)
What two things cause inflation
Adverse AS shocks
Positive AD shocks
Inflation caused by Positive AD shocks
Can inflation decrease while the price level increases?
12. Inflation can be decreasing while the price level is increasing as long as inflation is positive but falling. If the inflation rate is negative and moving toward zero, inflation is increasing at the same time the price level is decreasing (albeit at a slower rate each period).
why might it take longer for the effects of monetary policy to kick in ?
Because monetary policy changes i + c, which may take months to kick in. Fiscal policy spends G now.
What is quicker to start implementing, fiscal or monetary policy ?
monetary. fiscal is "too political"
How might a national debt burden our gov't to pursue proper fiscal policy?
A large national debt may cause the gov't to be burdened down with interest payments.
A trade deficit can only happen if...
a country's debt is financed by foreigners
"output is too low, and the price level is increasing"
ADVERSE SUPPLY SHOCK
what is the proper fiscal/monetary policy to fix "adverse supply shocks" ?
increase money supply, increase gov't spending, etc.
Explain all of the effects of an increase in taxes. Hint: think long run and short run.
21. An increase in taxes reduces disposable income which lowers both consumption and savings. Since investment equals savings in equilibrium, investment must also fall. Consequently the economy's capital accumulation is slowed and, thus, so is long-run aggregate supply. Since consumption falls, so does aggregate demand
if the price of peanut butter goes up, the demand for jelly goes (up or down)
down. It is a compliment
if we expect the price to go up tomorrow, when will the price reflect that expectation?
TODAY. the best measure for tomorrow's price is today's price.
HUGE change in quantity demanded with just a small change in price
SMALL change in quantity demanded with a large change in price
what is the equation for elasticity?
(%change in Q) / (% change in P)
Marginal product of labor
There comes a point where the marginal product of hiring an additional unit of labor is less effective. MPL = change in Output / Change in Labor. You adjust MPl so that MPL = MPK (see pg. 136)
increasing returns to scale
productivity gains are more than proportional to the increase in the size of the firm. ex. An assembly line's output can be doubled without doubling ALL of the inputs a firm employs.
What are explicit costs?
Accounting only takes into account explicit costs.
What are implicit costs?
perfect inelasticity of demand
perfectly inelastic (Ed = 0)
how much should every firm produce?
What determines if a firm should produce or not?
If (TR - VC) > 0, they should produce to minimize their losses. Think of Delta.
TR/q is the same as....
the market price! TR = pq ; and (pq) /q = p. WOW
When the market price minus AVC < 0 should a firm produce?
NO! A firm should only produce when p - AVC > 0. The market price MUST be greater than AVC to decide where to produce. WE SHOULD PROVIDE OUTPUT TO THE MARKET AS LONG AS MARGINAL COSTS ARE GREATER THAN AVERAGE VARIABLE COSTS. or MC > AVC (page 121 text book).
Ceteris parius, when the market price increases, what to competitive firms do?
Competitive firms increase production. They use Capital extensively and crank the heck out of Labor. (have their workers work overtime,etc)
Price elasticity of supply equation
%change in quantity supplied/ %Change in price.
When there are profits existing firms ______.
expand. New firms enter.
When there are losses existing firms ________.
Contract &/ exit.
What is the long run equilibrium?
When the rate of return on capital that new or existing firms might expect to earn is equal to the normal rate of return in other, comparable activities, elsewhere in the market
economies of scope
Economies in which materials and processes employed in one product can be used to make other, related products.
economies of scale
the property whereby long-run average total cost falls as the quantity of output increases; factors that cause a producer's average cost per unit to fall as output rises
constant returns to scale
the property whereby long-run average total cost stays the same as the quantity of output changes
When the world price (already below the market equilibrium) goes down does domestic production increase or decrease?
Decrease. It has become more costly to produce and less costly to import.
If the world price is above the market equilibrium will we import or export?
If the supply of yen increases, does the yen appreciate or depreciate.
(looking at a yen to dollars market) If the demand for yen increases does the yen appreciate or depreciate?
appreciate. It now takes more dollars to buy Yen.
equation for economic profits
TR-(TVC+TFC) -aka- total revenue - economic cost
elasticity point slope form
arc elasticity equation
Q2-Q1/[(Q2+Q1)/2] divided by P2-P1/[(P2+P1)/2)]
what is the elasticity of a 1) luxury good, 2) normal good and an 3) inferior good?
1) e>1 = normal luxury good
2) 0<e<1= normal good
3) e<0 = inferior good (pg 103)
what is the Cross Price elasticity equation, and what indicates wether the good is a compliment or a substitute?
percentage change in quantity of A demanded/ percentage change in the price of B
e>0 then A is a substitute for B.
e<0 then A is a complimentary good
What is allocative effencicy?
When resources are allocated in their highest valued use (aka all resources are used in their most productive way)
what is the role of prices in an economy?
prices convey information to both suppliers and demanders. Even though no effort for the information to be created / conveyed.
In these illustrations we can see that #1 has the absolute advantage in the production of A and B. But #2 has the comparative advantage in A. We let #1 specialize in B and #2 in A. This brings out the highest GDP for both economies
When the dollar appreciates against the Yuan, will there be more or less imports?
More imports, since the dollar is stronger compared to the Yen, the dollar can buy more Yen. Foreign goods become cheaper to the USA when the USD appreciates.
If the FED decreases the money supply does the demand for the dollar increase or decrease?
what is a "Protective Tariff" ?
a tariff imposed to protect local markets. ie- Mozambique egg tariff Fernando wants to put in place.
When there is a quota the world price falls, do imports increase, decrease, or remain the same?
with a quota imports remain the same when the world price falls. Imports would increase with a tariff.
effects of taxes
capital moves away from market.
What is aggregate savings?
Aggregate savings is What an economy can produce minus Consumption
What must be sacrificed in order for there to be economic growth?
In order for economic growth to happen we must forgo consumption today. We must save and use resources to produce capital.
What is the equation for Money Velocity?
MV = p*y
What happens if there is an increase in savings and desired investment remains the same?
AD decreases. If an economy is to grow aggregate savings must be kept in balance with aggregate investment.
if g > t , then the gov't is in a ________
deficit. If t>g then they have a surplus
do credit cards increase or decrease the demand for money?
increased inventories lead to _____
_____ is a tax on holding money
if ____ exists, people do not hold money
when _____ is unstable, it makes it very hard to negotiate
high and moderate _____ wipes out savings
inflation. It can also lead to wiping out the middle class
if everybody in the economy predicts that inflation will be 5% per year, then _____ also incrases at 5% per year.
when population grows and GDP does not grow accordingly
What are the 2 long run effects of countercyclical policies?
when the money supply decreases....
1-interest rates increase
2-Adverse AD shock
when money supply increases..
1-interest rates decrease
2-Positive AD shock
does the interest rate affect saving a little or a lot?
does the interest rate affect investment a little or a lot?
when saving maintains and investment falls, what happens?
What causes unemployment?
AD shocks and sticky wages.
0-0.99 elasticity of demand =
1 elasticity of demand =
1>elasticity of demand =
if the elasticity is greater than 1 demand is said to be elastic;
between zero and one demand is inelastic and
if it equals one, demand is unit-elastic.