Dr. John Lovett Macro Final

The study of how people, both as individuals and societies, make decisions when faced with wants that exceed their resources
A situation in which wants exceed means
Opportunity Cost
For a particular activity, the next best alternative foregone
Incremental, looking at small changes rather than the big picture
Pillars of Macro
Opportunity cost, incentives matter, marginal analysis, empirical testing
Factual; how the real world actually is and how it works
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
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
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.
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
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
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
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
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
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.
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
NOT adjusted for inflation
Real Values
Adjusted for changes in the price level. How much an item would be worth in base year dollars
GDP per hour worked
Circular Flow Model
Shows the basic components of an economy. Households are the ultimate owners of resources.
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
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
Legal and cultural norms that affect how things are done
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
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
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
Temporary reductions in spending, namely savings (S) and taxes (T)
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
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
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
1. A medium of exchange 2. A means of saving (or storage of wealth)
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
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
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