Dr. John Lovett Macro Final

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Economics

The study of how people, both as individuals and societies, make decisions when faced with wants that exceed their resources

Scarcity

A situation in which wants exceed means

Opportunity Cost

For a particular activity, the next best alternative foregone

Marginal

Incremental, looking at small changes rather than the big picture

Pillars of Macro

Opportunity cost, incentives matter, marginal analysis, empirical testing

Positive

Factual; how the real world actually is and how it works

Normative

What "Should Be"

Controlled Experiment

An experiment that can be repeated, and in which only one thing at a time is changed.

Ceteris Paribus

All else constant

Correlation

Patters or relationships. Do not always mean there's causation

Fallacy of Composition

The false belief that if something is true for an individual part, it is necessarily true of the whole system

Production Possibility Curve (PPC)

Shows all the combinations of two goods a person or economy can produce, given its available resources and technology

Consumption Goods (C)

Things that are used up quickly and do not build for the future

Investment (I)

Goods that, once produced, last quite a while and help us produce more in the future

Absolute Advantage

Being able to produce something for fewer resources

Comparative Advantage

Being able to produce a good at the lowest opportunity cost in terms of other goods

Market

Process by which sellers (supply side) and buyers (demand side) interact to exchange a certain type of good or service

Supply and Demand

A model of trade in a market

Law of One Price

The tendency for all sellers to charge the same price

Change in Demand

Occurs if the buyer's side of the market is the root cause of a change. Buyers change the amount they are willing and able to buy at a given price.

Quantity Supplied

Reaction by sellers to a change in price. The amount sellers are willing and able to sell at a given price

Change in Supply

Sellers are willing to bring a different amount to market, even if the price stays the same

Quantity Demanded

Reaction by buyers to a change in price. The amount of a good that buyers are willing and able to purchase at a particular price.

Demand

The relationship between the price of a good and the amount buyers are willing and able to buy

Law of Demand

The inverse relationship between price and quantity demanded. As price rises, Qd decreases. As price decreases, Qd increases

Supply

The relationship between price and quantity supplied

Law of Supply

As price rises, Qs increases. As price decreases, Qs decreases

Normal Goods

Goods for which demand increases as incomes rise

Substitutes

Goods that can serve as replacements for one another, when the price of one increases, demand for the other goes up

Determinants of Demand

Number or potential buyers, tastes or preferences, income of buyers, price of related goods, other

Complements

Two goods for which an increase in the price of one leads to a decrease in the demand for the other

things that Shift Supply

Costs of resources, production technology, number of potential buyers, other

Greed

People are motivated by self-interest. Results in GOOD to others

No Central Coordination

Decision making is largely atomistic and decentralized. Results in ORDER: The goods people want in right quantity and place

Invisible Hand

Markets are based on greed. Markets generally result in people doing good things for others. Because self-interest is a powerful and reliable motivator, many think markets benefit society

Natural GDP (Qnat)

The amount an economy produces when operating normally

Short-Run Goal

Getting the economy to normal capacity (the PPC) and keeping it there

Short-Run

The time period in which the economy can, without any government intervention, be away from its normal levels of output (Qnat) and employment. 0-5 years

Crowding Out

One sector of the economy taking resources away from another sector with bad consequences for (very) long run growth. A Long-Run problem.

Long-Run

The time period in which the economy can be expected to return to its normal levels of output (Qnat) and unemployment (Unat). 5+ years

Very Long-Run

The time period in which the economy's normal levels of output (Qnat) can show marked change. 25+ years

Growth of Capacity

Growing the economy's normal levels of output (Qnat) and (perhaps) reducing its normal level of unemployment (Unat)

Gross Domestic Product (GDP)

The $ value of all goods and services provided within a nation's borders, and sold in legal markets, each year

Ways to measure GDP

1. Adding up the selling price of all final goods and services produced 2. Adding up all income created in an economy

Material Standards of Living

A product of the goods and services a nation provides for its citizens

Value Added

The difference between a good's selling price and the "intermediate goods" used to make the good

Nominal

NOT adjusted for inflation

Real Values

Adjusted for changes in the price level. How much an item would be worth in base year dollars

Productivity

GDP per hour worked

Circular Flow Model

Shows the basic components of an economy. Households are the ultimate owners of resources.

Inflation

The percentage change in the general price level per year. Inflation= ( ( Cost t - Cost t-1) / Cost t-1 ) ) X 100%

Market Basket

The list of typical goods a person in the target group buys

Price Index

How much the market basket costs in that year relative to what it cost in the base year. PI= ( Cost in year t / Cost in base year ) X 100

Unemployment

Being able and willing to work, but not working

Labor Force

Only includes those who are BOTH willing AND able to work

Unemployment Rate

The percentage of those in the labor force who are without jobs

Frictional Unemployment (Ufric)

Unemployment due to the length of time the normal job search takes

Structural Unemployment (Ustruc)

Results from workers not having the skills or being in the location that firms want

Natural Unemployment (Unat)

Frictional Unemployment (Ufric) + Structural Unemployment (Ustruc)

Cyclical Unemployment (Ucyclical)

Results when the economy is not at its normal capacity

Actual Unemployment (Uact)

Cyclical Unemployment (Ucyclical) + Natural Unemployment (Unat)

Capital (K)

Physical capital; man-made goods used to produce other goods and services

Production Process (P)

Captures technology, legal institutions, and any other aspects affecting how an economy uses its resources

Labor (L)

The Number of adults of working age

Natural Resources (N)

Land, fossil fuels, etc.

Output (Q)

The combination of capital (K), labor (L), and natural resources (N), through the production process

Law of Diminishing Returns

Increasing input by X % will increase output, but by less than X %

Marginal Return

Incremental Increase in Output

Institutions

Legal and cultural norms that affect how things are done

Incentive

Something that induces a person to act

Property Rights

The right to reap the rewards (and costs) of one's actions. The right to do what you want with your resources, the right to transfer property, the right to have your resources protected from damage by others without your permission

Intellectual Property Rights

The Patents and Copyrights that establish temporary ownership of ideas, processes, artisitc creations, and written works

Good Rule of Law

Rules by which people and businesses play are known and fixed. People make decisions confidently knowing that the government will not arbitrarily change the business environment

Externalities

Instances in which people other than the buyer and seller are affected

Fiscal Federalism

A system of government in which each layer of government has different powers and responsibilities. State governments compete in a healthy way to provide the best economic environment

Government Transfers

Occur when the government takes income from one person and gives it to another person, but receives nothing in exchange. Taxes

Conscription

The government commands that more resources go to the government. "Great Leap Forward" in 1950's China and a modern military draft

Government Crowding Out

Conscription, taxation, printing money, borrowing, consumption

Leakages

Temporary reductions in spending, namely savings (S) and taxes (T)

Injections

New sources of spending funded by leakages, namely investment (I) and government spending (G)

Government Spending

Taxes (T) + Government Borrowing

Business Cycle

Short-run fluctuations around normal capacity

Aggregate demand and aggregate supply model AD-AS

Used to analyze economic fluctuations

Aggregate Demand

The amount of spending on domestically produced goods. Varies with the price level (C+I+G+X-M)

Foreign Purchases Effect

When U.S prices rise, foreigners find U.S goods more expensive and exports (X) fall. Americans find foreign goods cheaper and buy more imports (M). Aggregate Demand slopes down

Short-Run Aggregate Supply (SRAS)

Intersects with AD to determine where an economy is in the short run

The Real Balances Effect

Assets such as savings accounts, bonds, etc. keep the same nominal value even if the economy experiences inflation

Long-Run Aggregate Supply (LRAS)

Represents the economy's natural rate of production (PPC)

Fiscal Policy

Government spending and taxation

Monetary Policy

Government actions to affect the amount of money in an economy and interest rates. The Federal Reserve putting money into the economy and cutting interest rates during a recession by buying government bonds

Stagflation

The combination of rising inflation and stagnating output

Non-activist View

Classical or new-classical view. The government should not take an active role in trying to keep the economy at or near its PPC. The Private sector is inherently stable and can take car of itself

Activist View (Keynesian)

The private sector spending is inherently unstable. Private individuals and first base most of their decisions on what they see and feel right now rather than on slowly changing long-run trends.

John Maynard Keynes

Author of "The General Theory of Employment, Interest, and Money" (The General Theory). The biggest proponent of the activist view

Wage Illusion

The fixation on nominal rather than real wages

Liquidity Trap

Phenomenon in which the financial sector hoards cash, a very liquid asset, instead of lending it out

Counter-cyclical

Going against the business cycle

Discretionary Fiscal Policy

Policy makers changing the tax and spending laws

Fiscal Stimulus

The initial wave of increased spending by government and households spending their tax cuts

Re-spending Effects

Give the stimulus an extra boost

Recognition Lag

The time it takes people to realize that the economy is in a recession. 6 months after an economy enters a recession for it to become widely recognized and the recession to become a major political issue

Policy Lag

The time it takes policy makers to actually change the laws

Automatic Fiscal Policy

Changes in tax collections and government spending, with no change in budget laws, as the economy moves through the business cycle

Discretionary, counter-cyclical fiscal policy

The recommended fiscal policy of Keynesians/Activists

Money

1. A medium of exchange 2. A means of saving (or storage of wealth)

Barter

Requires a double coincidence of wants. Quantities and qualities must also match. Encourages people not to specialize and therefore lowers living standards

Commodity Money

The commodity itself or a piece of paper backed by the commodity

Fiat Money

Money that has no intrinsic value as a commodity. It is simply money because that is what society has chosen to use as money

Liquidity

Refers to how quickly and easily an asset can be sold for its "normal" value

Fractional Reserve Banking

The reserves a bank keeps are only a fraction of the amount people have deposited in the bank

Financial Intermediation

Channeling the money of savers into the hands of borrows. Much of this borrowing goes to physical investment. Without it, there would not be near as much physical investment

Required Reserves Ration (R)

Ratio instilled by the Federal Reserve that balances how much reserves a bank has to hold to back each $1 of checking. Usually 10%

Excess Reserves

Any cash the bank holds above and beyond its requires reserves

Required Reserves

The amount of reserves a bank has to hold to back each $1 of checking

Deposits Insurance

Banks paying money into a fund. Money is used to insure savers' deposits should the bank fail

Lender of Last Resorts

Government loans to banks when banks need cash and can not get it from each other

Discount Rate

The interest rate the Fed charges banks

Central Bank

The only institution in a country that can print and issue currency. Acts as a lender of last resort. Conducts monetary policy

United States Federal Reserve

The central bank for the U.S; regulates the banking industry. Acts a check clearinghouse between banks. Can often afford to ignore popular and political opinion

Clearinghouse

A place where banks exchange checks and settle accounts

Board of Governors

The seven-member board that acts as the main decision-making body for the Fed

Ben Bernanke

Chair of the Federal Reserves. Chief among Board of Governors

Monetary Stimulus

Trying to increase the money supply, encouraging lending by banks, and pushing interest rates down. Increase spending and aggregate demand

Monetary Restraint

Taking steps to decrease the money supply, discouraging lending by banks, and driving interest rates down

Troubled Asset Relief Program (TARP)

Program in which the government buys many of a bank's loans and other assets in danger of default. In return, the government receives an ownership stake in the bank

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