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Terms in this set (117)
item bought by the user
bought by another firm, used to produce final good
GDP = ? = ?
GDP = aggregate expenditure = aggregate income
The expenditure approach
C + I + G + X - M
The Income approach
Compensation of employees + rental income + corporate profits + net interest + proprietor's income + indirect taxes - subsidies paid by gov't + depreciation
Nominal vs. Real GDP
real GDP = from a base year
How to calculate nominal GDP
P1 x Q1 + P2 x Q2
How to calculate real GDP
P base year x Q1 + P base year x Q2
up and down irregular movements of growth
1. Recession/Expansion (increasing/decreasing)
2. Peak/Trough (tip and low points)
unemployed + employed
without a job but currently looking for a job
How to calculate unemployment rate
# of people employed / labor force X 100%
How to calculate employment to population ratio
# of people employed / working-age population X 100%
How to calculate labor force participation rate
labor force / working-age population X 100
Marginally Attached Worker
not working or not currently looking for a job, but has indicated that they want a job in the past
has stopped looking for a job because of a repeated failure to find one
persistently rising/falling price level
Consumer Price Index
measure of the average prices paid by a consumers for a fixed basket of G & S
How to calculate CPI
cost of CPI basket at current prices / cost of CPI basket at base-period prices X 100
How to calculate cost of CPI basket
Q1 x P1 + Q2 + P2
How to calculate inflation rate
(price level this year - price level last year) / price level last year X 100%
* could also use CPI instead of price level
How to calculate GDP deflator
nominal GDP / real GDP X 100
Base year GDP deflator always equals...
increase in labor hours = increase in real GDP
inputs (labor, capital, energy) --> technology --> outputs
How to calculate real wage rate
money wage rate / price level X 100
Classical growth theory (aka malthusian theory)
growth of real GDP is temporary and population explosion eventually brings it back down
Neoclassical growth theory
-technological change influences economic growth, but not the other way around
-technological change results from chance
New Growth theory
-choices people make in pursuit of profit drives growth
-technological change NOT by chance
-PROFIT spurs technological change
What year/country does GDP count in?
The year & country that the good was PRODUCED
Steeper slope =
Highest line =
greatest economic growth
highest GDP per capita
CPI overstates inflation if
price increase > inflation increase
Law of diminishing returns
additional factors of production causes a smaller and smaller increase in outputs
Economic growth after a natural disaster; explain
-capital lost because of bomb/disaster
-remaining capital is more productive because of diminishing returns
-this leads economic growth back to pre-disaster
-with technological change, growth will be higher than pre-disaster
Largest part of input costs
If one price changes and other doesn't (and they're both substitutes) explain change in consumer behavior and why CPI doesn't accurately reflect inflation
-price of good A rose, but price of good B stayed the same
-since the two goods are substitutes, consumers are going to purchase the good with the lower price (good B)
-CPI counts substitutes as the same good in its calculation, which is why inflation is overstated in order to compensate
When inflation line > 0
When inflation line < 0
price level rising
price level falling
Economic growth is NOT caused by
increases in population
"means of earning" "means of payment"
a good used as money (ex. gold)
no intrinsic value itself; regulated by gov't or law
currency + checking deposits
M1 + savings deposits + money market mutual funds + other deposits
-federal funds loan
what the bank owes to other banks & the central bank
= total assets - total liabilities
How to calculate required reserves
(checking deposits) (Reserve Ratio)
How to calculate excess reserves
total reserves - required reserves
How to calculate Money Supply (MS)
Monetary Base X Multiplier
How to calculate multiplier
Q of real GDP supplied and price level
-wages are sticky (price of inputs remains fixed)
-Firms produce where price of output = marginal cost
-Firms produce more for higher profits, which also increases demand for labor
-MC cost curve sloping upward
-input prices --> inverse relationship
-anything else that shifts LRAS shifts SRAS
-money wage rate changes in step w/ price level to maintain potential GDP level
-vertical line = potential GDP
-technology --> direct relationship
-quantity of capital --> direct relationship
-full employment quantity of labor --> direct relationship
When potential GDP increases...
LAS and SAS curves shift right
Q of real GDP demanded and price level
-when price level rises, income stays the same and real wealth decreases (because value of savings does not rise with price level & wages are sticky)
-People would need to restore wealth by increasing savings and decreasing consumptions
-fewer G & S demanded --> AD decreases
-rise in price level decreases real value of money
-with a smaller amount of real money, banks and other lenders can get a higher interest rate on loans
-higher interest rates discourage people from borrowing to make invesment --> AD decreases
income - taxes + transfers
Can someone who has 0 disposable income consume?
Yes, they can use their savings or take out a loan
Lifetime income hypothesis
consumption is not determined by level of income at a certain point, but by the whole lifetime income
temporary change in people's income does not affect spending that much... but permanent does
Factors that shift the AD curve
1. Taxes (inverse)
2. Interest rate (inverse)
3. Gov't spending
5. Quantity of money (MS)
6. Expected future income
7. Expected future profit
11. Foreign income
What causes a movement along AD curve?
price level (inverse)
If amount of loanable funds or savings increases, than interest rates ___?
Government savings =
Taxes - G -Transfers
How do governments survive negative savings (since taxes are usually less)?
running a budget deficit
When savings increase, budget deficit _____
Government uses G, Taxes or transfers to influence GDP
Crowding out effect
-government tries to reduce taxes
-investment decreases as an indirect result of the increase in savings
-counteracts the intended effect of fiscal policy on real GDP
Ricardian Equivalence aka Ricardo Barro Effect
economic agents perceive a reduction in taxes now as an implication of future increases in taxes, so they consume less and save more for the future "hard times"
If domestic price level increases
-goods of that country become more expensive abroad
-foreign goods become cheaper & are demanded more
Purchasing power parity
if PPP holds, any change in price level leads to change in exchange rate
Why do banks with more liquid liabilities have a higher reserve requirement?
they are more likely to face unexpected deposit withdrawals
What does deposit insurance do?
pays bank customers if the bank has insufficient assets to cover their deposits
If Fed buys large amounts of bonds... the MS _____ and interest rates on bonds _______
Increase in price level shifts
neither AD nor SRAS curves
Interest rates relationship with price level and real GDP
inverse with both
What is always included in definition of money?
Largest component of aggregate demand
Excess reserves & multiplier relationship
If prices of all inputs and outputs rose by ___%,
real wage stays the same and GDP produced stays the same
If prices of all inputs & outputs declined by ___%
real wages rises and GDP produced declines
Why is the SRAS slanted?
-sticky wages are responsible
-when price levels increase, wages do not because they are sticky
-profit maximizing firms produce where marginal benefit equals marginal cost
-if the price of outputs increases, firms will produce a higher quantity of outputs
-this increases aggregate supply, hence the upward slope of the SRAS
A bank wants to make a loan. If the bank obtains funds to lend by selling bonds to the Fed, explain
how this changes the monetary base and how it ends up changing the money supply. Explain also why the
final change in the money supply is generally larger than the change in the monetary base, whereas the
change in the monetary base is exactly the same as the bond sale.
1. MB increases due to the Fed's purchase of the bonds: when the Fed buys the bonds, they pay
for them by crediting the bank' reserves account, and thus increasing the amount of excess
reserves, which increases MB.
The MB increases by the same amount at the $ amount of the bonds sold while the MS will
increase by that amount times the multiplier.
2. Through the bank's lending activity, the final change in MS is generally larger than the change
in MB because Money Supply (MS) will increase by a multiplication of the increase in MB:
MS=MBxMultiplier. MB= Currency + Reserves, therefore the MB increases by the same amount at the $ amount of bonds sold
Does the real wage rise or fall and why?
Falls if price level increases
Rises if price level decreases
Nominal wage does not change because of sticky wages, but price level changes so that's why the real wage rises/falls
Why are GDP and the price level the point where the AD and SRAS cross?
In SR, nominal wage is sticky so the SRAS adjusts in the long run equilibrium
3 things that change the multiplier
1. Reserve requirement (inverse)
2. Excess reserves (inverse)
3. Consumer confidence (direct)
ratio of change in MS to MB
How to determine change in multiplier through MS and MB graphs
If MS slope is steeper than MB slope
and then MB slope is steeper than MS slope
The economy's self-correcting mechanism to eliminate a recessionary gap
-something happens that causes the AD curve to shift to the left so that real GDP is less than potential GDP
-over time, the SRAS shifts to the right (wages drop) in order to compensate for this so that the gap is closed
The government closing recessionary gap through fiscal policy
-government does something to shift AD curve to the right in order to close the gap
If the fed buys/sells bonds, what happens to money supply and interest rates?
Buys --> MS increases, IR decreases
Sells --> MS decreases, IR increases
According to monetarists, the main cause of recessionary and inflationary gaps are
changes in the quantity of money
Buying assets _____ return the economy to long-run equilibrium
Selling assets ___ return the economy to long run equilibrium
A base year is a year that we use as a benchmark for adjusting
If average wage and CPI increases, the real wage has
risen, because nominal wage grew faster than the CPI
If GDP deflator increases, then real GDP growth must have been
less than the nominal GDP growth
If real GDP grew faster than another country, this might be because
investment was very high in that country because the return to capital was higher than the other
In some countries, the government awards money to unemployed workers. Which would be the most appropriate measure of the price level to achieve this goal?
M1 + M2 + M3
currency + reserves
What is the purpose of "capital requirements?"
to ensure that default by a large borrower is unlikely to make a bank insolvent
Are credit cards included in the MS definition?
No, they are tools for obtaining short-term loans, so they're not included
-the link between unemployment and inflation depends on whether policy changes are anticipated or unanticipated
-if expected inflation rises, a given rate of unemployment is linked to a higher rate of inflation
When a fed makes a discount loan to a bank...
the MB and the MS increase
What is the most frequently used tool of monetary policy?
open market operations
If workers negotiate wage compensation that accounts for inflation, the economy will
tend to be at potential GDP
Decreasing marginal returns means that
investment in physical capital may contribute to growth, but cannot keep it going forever
the ease with which an asset can be converted into cash
If the AD curve experiences a shock that shifts it to the left, and they want to hit the inflation target...
there will be no recessionary gap & the AD ends up where it would have gone in the absence of the shock
If the SRAS curve experiences a shock that shifts it to the left and they want to hit the inflation target...
there will be a recessionary gap
Inflation is likely to be high and sustained when
the fed accommodates people's anticipation of high inflation
What is inflation rate when AD change is unexpected?
AD moves to right; there is an inflationary gap
What is inflation rate if change in AD was anticipated?`
SRAS shifts to left, like a wedge (GDP doesn't change, only inflation rate does) ; there isn't a gap
Shifts because if people anticipate the demand movement, they know that there will be inflation and thus there is an increase in pressure for wages to rise. This shifts SRAS curve to the left because of an increase in costs.
Why is it easy for the Fed to offset unexpected changes in AD without affecting changes in expected inflation?
Because the Fed just pushes AD back to where it was before. This closes the output gap and confirms people's expected inflation.
Why will the Fed's response to an unexpected change in the SRAS either lead to prolonged inflation or a big recession
if the Fed stabilizes GDP, it makes inflation higher, indicating that people expect higher inflation in the future which shifts the SRAS curve even more. If they try to keep inflation unchanged, this exacerbates the impact of the SRAS on output, which is not stabilizing.
To calculate short run macro equilibrium...
set SRAS and AD curve equal to each other
Solve for P and plug P back in
that number and P is equilibrium
Output gap definition
equilibrium GDP - potential GDP
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