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Terms in this set (75)
What is the Loanable Fund Market?
Where the economy's savings is made available to those who need additional funds
How can households supply their savings?
put their funds into a bank, buy bonds, buy stocks
What is Say's law?
total spending=total output
Q of funds supplied(S)=Q of funds demanded (Ip+(G-T))
What makes the fiscal policy graphs different?
No demand-side effects but has all the supply-side effects
-An Increase in G
-A decrease in T
What is crowding out mean?
A decline in one sector's spending caused by an increase in some other sector's spending
What does complete crowding out mean?
A dollar for dollar decline in one sector's spending caused by an increase in some other sector's spending
Why do some countries grow faster than others?
Current growth determines future grow
70/rate of growth=number of years for the variable to double in size
What is economic growth?
refers to a rise in a country's standard of living
standard of living
-refers to material basis of well-being
changes in producitivity is due to productivity differentials
What determines economic growth?
Determinants of GDP
-the average hours worked
-the emloyment-population ratio
-the size of the population
How do you find the real GDP?
productivity x average hours x EPR x Population
How do you find the GDP per capita?
the change of percentage of productivity+ the change of average hours + the change in EPR
What is the most important thing in GDP?
What's the difference between the classical model and the short-run macro model?
In the classical model: production determines spending
In the short-run macro model: total spending determines the level of production
What is the formula for the disposal income?
How is wealth calculated?
total value of household assets-liabilities
What is the consumption function made of? What's the difference from the consumption line?
Consumption and Disposable Income while the consumption line is real income.
What is autonomous consumption?
the part of consumption spending that is independent of income: Y-intercept of the consumption function
What is the Marginal Propensity to Consume formula?
MPC= Change in Consumption/ Change in Disposable Income
What is the consumption function equation?
C=a+bxDI (b=slope of curve=MPC)
What will move the consumption function equation and what will shift it?
• ∆ in Wealth
• ∆ in Interest rates
• ∆ in Households' perception of the future
What will move the consumption-income line and what will shift it?
• ∆ in Autonomous C due to:
− ∆ Wealth
− ∆ Interest rates
− ∆ Households' perception of the future
• ∆ in Net Taxes
What is the formula for the y intercept of the consumption-income line?
a - MPC × T
What is the formula for AE(aggregate expenditure)
AE=consumption+income+government spending+net exports
How does AE and the GDP affect inventories?
AE>GDP=decrease in inventories
AE<GDP=increases in inventories
AE=GDP=inventories do not change=no change in GDP
What is the formula for the multiplier?
Change in GDP is equal to what?
m x change in autonomous spending
What is held constant with the m*?
o We assume that net taxes are held constant (do not change with income → ↑ in income = ↑ in DI)
o Net Exports are held constant
o Household wealth is held constant
o Investment is independent of income (autonomous investment)
What is the definition of automatic stabilizer?
A feature of the economy (economic variables) that reduces the size of the expenditure multiplier and diminishes the impact of spending changes on real GDP. They smooth out the business cycle.
What are the automatic stabilizers? (list included)
a. Taxes and Transfers that depend on income (Taxes ↑ and Transfers↓ when Income ↑):
o Taxes change when income change (progressive tax system)
o Income↑ → Taxes ↑ + Transfers↓ → DI↑ by less than income → C↑ by less than it would be if NT were held constant→ this leads to fewer rounds of consumption spending
b. Imports: Out of each additional dollar spent on goods and services, about 15 cents goes to imports. This spending does not stimulate additional domestic production, hence there are fewer rounds of spending.
m when imports depend on national income = 1/(MPS+MPI)
c. Forward-looking behavior:
o When increases in DI are view as permanent → spending is higher → MPC and m is higher
o When increases in DI are view as temporary → spending is lower → MPC and m is lower
**Make the multiplier smaller
What is the definition automatic destabilizer?
A feature of the economy that increases the size of the expenditure multiplier and enlarges the impact of spending changes on real GDP.
What are the automatic destabilizer?
a. Asset Prices, Wealth and Consumption:
o As the economy expands, so do profits and stock prices go up. The D for homes goes up and so do the price of houses → households' assets (wealth) ↑→ C↑: this is an additional rise in consumption spending beyond the increase in C caused by the initial change in autonomous spending. Thus C ↑by more than when households' assets were assumed to be constant. This leads to more rounds of spending making the business cycle more volatile.
b. Output and Investment Spending:
o If investment depends on income (induced investment) additional rounds of spending will be added to those caused by the initial change in autonomous spending . As GDP rises, firms approach the limits of their productive capacity; to increase production further they purchase new plant and equipment. As people have more money, the D for new homes increases → P↑, companies make new houses.
**this makes the multiplier bigger
What is the value of the multiplier in the long run?
the value of the expenditure multiplier is zero: no matter what the change in spending, the economy will always return to its potential GDP (the economy cannot be above or below FE in the long run).
How can the Fed change the money supply?
-Through open market operations (buying/selling gov bonds in the open market)
-changing the required reserve ratio (RRR)
-by changing several interest rates (the discount rate, the interest rate on reserves (IOR), or the federal funds rate)
What is the money multiplier formula?
Change in Money Supply=MmxReserve Injections
What reduces the size of the multiplier?
-public could change their behavior and keep some of the increases in the money supply as cash, hence depositing less money at their respective banks
-banks may decide to hold excess reserves and if so, they will lend out less money
What's the big problem with the Mm?
The Mm is oversimplified because it ignores changes in the bheavior of the public and the banks that can reduce the value of Mm.
What happens to MS when RRR increases and decreases?
When RRR decreases, MS increases. When RRR increases, MS decreases.
How do the interest rates affect the money supply?
When DR/ IOR/ FFR decreases, MS increases. When DR/IOR/FFR increases, MS decreases.
What is in M1?
Cash in the hands of the public
Checking account deposits
What is in M2/What's the difference?
Money market deposits
Money market funds
Certificates of deposit under $100,000
The difference is that this is all savings while M1 is based on money that is there right now.
What can money be used as?
a means of payment
store of value
unit of account
What is commodity money?
Precious metals and other valuable commodities
Important uses other than means of payment
The non-money use is what gave commodity money its ultimate value
What is flat money?
Something that serves as a means of payment by government declaration (= Paper Currency)
What is financial intermediacy?
A business firm that specializes in brokering between savers and borrowers
Savings and loan associations
Mutual savings banks
What is the structure of the fed Reserve system?
7 Board of Governors + 5 Reserve Bank Presidents + 3 Directors of 12 Federal Reserve Banks
What is the function of the Fed?
Supervising and regulating banks
Acting as a "bank for banks"
Issuing paper currency
Guiding the macroeconomy
Dealing with financial crisis
What is a household's demand for money?
− Wealth can be held in different forms: cash, bonds, stocks.... Households choose how to divide wealth between: (1) money, which can be used as a means of payment but earns no interest; and (2) other assets, which earn interest or other financial returns, but cannot be used as a means of payment.
− The quantity of money demanded is the amount of wealth people wish to hold as money rather than as other assets.
− The opportunity cost of holding money is the interest payment (or other financial return) you could have earned by holding other assets instead.
− What determines how much money do we want to hold?
ο The price level: the higher the prices the more money we need to carry out our transactions
ο Real income: if real income increases we will spend more money in purchases so we will need to hold more of our wealth in the form of money
ο The interest rate: interest payments are what we give up to hold money. The higher the interest rate, the greater the opportunity cost of holding money. Thus, a rise in the interest rate decreases the quantity of money demanded.
What is the business demand for money?
the quantity of money demanded by businesses follow the same principles we have developed for households.
What is the economy's demand for money?
the quantity of money demanded is the amount of total wealth in the economy that all households and businesses, together, want to hold as money rather than other assets.
What does interest rate do to the demand curve?
An increase in interest rate moves us left on the interest curve. A decrease in interest rate moves us right on the interest curve.
If the price level or income increases it shifts outward
What is the supply of money?
The supply of money is the amount of money supplied at each interest rate. The supply of money is the amount of money (cash and demand deposits) that the fed and the banking system have created.
How does the money market reach equilibrium?
At a higher interest rate, an excess supply of money causes interest rate to fall.
-• ir > ir* → Excess supply of money → D for bonds goes ↑ → PBonds↑→ ir↓
At a lower interest rate, an excess demand for money causes the interest rate to rise.
-• ir < ir* → Excess demand for money → S of bonds goes ↓ → PBonds↓→ ir ↑
How/Why can the Federal Reserve change interest rate?
Why: to prevent the economy from overheating or slipping into recession & to maintain an interest rate target.
How: Through the open market purchases or sales
➢ the Fed wants to decrease the interest rate (expansionary MP):
FED CONDUCTS OPEN MARKET PURCHASES→ MS ↑ → EXCESS SUPPLY OF MONEY SO THE DEMAND GOES UP FOR BONDS→ PBONDS ↑→ ir ↓
➢ the Fed wants to increase the interest rate (contractionary MP):
FED CONDUCTS OPEN MARKET SALES → MS ↓ → EXCESS DEMAND FOR MONEY SO THE SUPPLY OF BOND GOES UP → PBONDS ↓→ ir ↑
What happens when monetary supply and demand changes?
the interest rate changes if the MD or MS shift. MD shifts if the PL or rGDP changes. MS shifts if the Fed changes its monetary policy.
How do interest rates affect the economy?
− When the Fed ↑ MS, the ir ↓ → ↑ spending in plant and equipment, housing, and consumer durables
− When the Fed ↓ MS, the ir ↑ → ↓ spending in plant and equipment, housing, and consumer durables
What happens to the GDP through open market sales/purchases?
FED CONDUCTS OPEN MARKET PURCHASES: → through the Mm MS↑ → ir↓→ a and Ip ↑ →↑AE → through the multiplier rGDP↑
FED CONDUCTS OPEN MARKET SALES: → through the Mm MS↓ → ir↑→ a and Ip ↓ →↓AE → through the multiplier rGDP↓
What is the full-employment output level?
the output level that results when the labor market clears
Say's Law assures us______________________.
that in the aggregate, firms are able to sell their output so that full employment can be sustained.
Why is the supply of loanable funds curve is upward-sloping?
Because a rise in the interest rate increases the opportunity cost to households of consuming
What is the relationship between household saving and business investment spending in equilibrium?
planned investment=household saving-government spending+taxes
What is economic growth defined as a long-run increase in an economy?
total outputs of goods and services
What is the total output equation?
Productivity x Average Hours x the employment-population ratio x Population
What if labor demand and labor supply increased?
Increase: Employment and real output will decrease but the effect in the real wage depends upon the magnitudes of the shift.
What combination of government policies would be most likely to increase labor supply?
decreasing income tax rates and cutting transfer payments to the needy
What would unambiguously increase consumption spending?
A decrease in the interest rate coupled with an increase in real wealth
What's the most important factor that influences total spending?
real disposable income
What does not increase autonomous consumption spending?
Increased disposable income
What could cause upward shifts in the consumption function?
A decrease in the interest rate
What is an important assumption in the short-run macro model?
Prices do not change.
What is the relationship between income and investment spending in a short run macro model?
There is no relationship between the two variables.
What will happen to inventories if AE is less than GDP?
Inventories will grow and GDP will fall.
Suppose the economy is in equilibrium, when business firms decide to increase investment spending by 100 billion. According to the short-run macro model, what would be the effect on equilibrium and real GDP?
It would increase by more than 100 Bill.
What shifts the AE line upward?
an increase in autonomous consumption spending.
What does the automatic stabilizers reduce fluctations in GDP?
It reduces the additional spending thatoccursin each round of the multiplier
What happens in a short run model with actual output?
Actual output can deviate from potential output.
Recommended textbook explanations
Gary E. Clayton
Cambridge IGCSE Business Studies
Karen Borrington, Peter Stimpson
Explorations in Economics
Principles of Economics
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