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Macroeconomics 20200 Exam 1
Terms in this set (162)
A situation in which unlimited wants exceed the limited resources available to fulfill those wants.
The study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided.
Three Economic Questions
1. What products do we produce?
2. How do we produce the products?
3. Who consumes the products?
Factors of Production
Land, labor, human capital, capital, and entrepreneurship
The branch of economics that examines the economic behavior of aggregates- income, employment, output, and so on- on a national scale.
The best alternative that we forgo, or give up, when we make a choice or decision (subjective).
Costs requiring a money payment.
Costs not requiring a money payment.
Law of Diminishing Marginal Returns
The principle that as successive increments of a variable resource are added to a fixed resource, the marginal product of the variable resource will eventually decrease.
Unintended consequences of economic actions that may develop over time as people react to events.
A reward that encourages an action or a penalty that discourages an action.
The process of analyzing the additional or incremental costs or benefits arising from a choice or decision.
An examination of the effects of additions to or subtractions from a current situation.
A measure of pleasure or satisfaction.
Costs that cannot be recovered or diverted towards alternative uses.
Normative (questions) Economic Analysis
Addresses questions that involve value judgements. It concerns what ought to happen rather that what did, will, or would happen.
Positive (questions) Economic Analysis
Addresses factual questions, usually concerning choices or outcome. It concerns what did, will, or would happen.
A set of ideas about the economy organized in a logical framework.
A simplified description of some aspect of the economy or a presentation of economic phenomenon that takes a mathematical and/or, conceptual, and/or graphical form.
Ignoring many details so as to focus on the most important elements of a problem.
Explain a lot with a little.
A variable that is explained by an economic model.
A variable that is taken as given and is not explained by an economic variable.
Ceteris Paribus (All Else Equal)
A device used to analyze the relationship between two variables while the values of other variables are held unchanged.
Factors that Influence Spending Behavior
Income, taxes, real interest rate, expected future income, wealth, weather, other exogenous factors.
Terms that contain the prejudice and value judgements of others- appeal to emotion, inflammatory language, etc.
Fallacy of Composition
What is true for one individual or part of a whole is necessarily true for a group of individuals or the whole; the false notion that what is true for the individual is necessarily true for the group.
Expressing what has not happened but could, would, or might under differing conditions. What ifs, thought experiments, alternatives to actual history; they imagine what would have happened to an economy if, contrary to fact, some present condition were changed.
Post hoc Fallacy
The false belief that when one event precedes another, the first event must have caused the second event; when two events occur in the same sequence, the first event is not necessarily the cause of the second event.
Correlation vs Causation
Events may be related without a causal relationship.
A systematic and dependable association between two sets of data; does not necessarily indicate causation.
A relationship in which the occurrence of one or more events brings about another event.
Selecting statistics that support a particular thesis and drawing attention to those numbers, while ignoring other figures that might lead to a different conclusion; cherry picking.
An argument that misrepresents a position in order to make it appear weaker than it actually is, refutes this misrepresentation of the position, and then concludes that the real position has been refuted.
An efficient economy is one that produces what people want at the least possible cost.
An increase in the total output of an economy.
A condition in which national output is growing steadily; with low inflation and full employment of resources.
Growth Rate Formula
%change X = X(t+1) - X(t) / X(t) * 100%
Rule of 70 (72)
The approximate amount of time it takes for the level of a variable growing at a constant rate to double:
T2 = 70/R
T2: approximate time for variable to double
R: constant (average) growth rate percent
Use 70 for numbers ending in 0, 2, 5, 7, 10
Use 72 for numbers ending in 3, 4, 6, 8, and 9
Time Series Data
Data for the same entity for multiple time periods.
Data collected for different entities in a single time period.
Data for multiple entities where each entity is observed in two or more time periods.
Gross Domestic Product (GDP)
The market value of all final goods and services produced in a country during a period of time, typically one year or quarter. Measured by BEA. Only new goods and services- no double counting.
Y = C + I + G + NX
G: Government Purchases
NX: Net Exports
Goods that last three years or more.
Spending by firms on new factories, office buildings, and additions to inventories, plus spending by households and firms on new houses.
Goods used up during production in the same period that they themselves were produced. Not included in calculation of investment.
The value of exports minus imports.
The value of final goods and services evaluated at base-year prices. Base year is arbitrary. Use to avoid exaggerating growth.
The value of final goods and services evaluated at current-year prices.
GDP Deflator Equation
GDP Deflator = Nominal GDP/Real GDP * 100
Used to measure price level
Shortcomings of GDP as a Measure of Well-Being
Does not account for the value of leisure, GDP and the environment, crime and other social problems, or the distribution of income.
GDP - consumption of fixed capital (GDP - depreciation)
Income received by households, includes transfer payments, but excludes firms' retained earnings.
Disposable Personal Income
Personal income - personal tax payments. Measures the amount that households are able to spend or save.
A measure of the average prices of goods and services in the economy.
pi = P(t) - P(t-1)/P(t-1) * 100
pi: inflation rate
P: price level
Consumer Price Index (CPI)
A measure of the average change over time in the prices a typical urban family of four pays for the goods and services they purchase.
CPI = Expenditure in current year/Expenditures in base year * 100
Overstates true inflation by 0.5-1 percentage points due to biases.
Consumers may change their purchasing habits away from goods that have increased in price.
Increase in Quality Bias
Products like cars and computers have become more durable and better quality over time. It is hard to isolate the pure inflation part of price increases.
New Product Bias
The basket of goods changes only every 10 years. There is a delay to including new goods like cell phones.
Increases in purchases from discount stores like Sam's Club or the Internet are not incorporated into the CPI: it still uses full retail price.
Producer Price Index (PPI)
An average of the prices received by producers of goods and services at all stages of the production process.
Calcualting Purchasing Power
Value in X Year dollars = Value in Y Year dollars * (CPI in Year X/CPI in Year Y)
i = r + pi
i: Nominal Interest Rate, the return to saving and the cost of borrowing without adjustment for inflation
r: Real Interest Rate, the return to saving and the cost of borrowing after adjustment for inflation
pi: inflation rate
Federal Funds Rate
The interest rate that the banks charge each other on overnight loans.
London Interbank Offered Rate (LIBOR)
The most active interest rate market in the world. It is determined by rates that banks participating in the London money market offer each other for short term deposits.
Prime Interest Rate
The interest rate charged by banks to their most creditworthy customers. Benchmark that banks often use in quoting interest rates to all of their customers.
Inflation rate is greater than or equal to 50% per month.
The sum of employed and unemployed workers in the economy.
Worked 1 or more hours within the week.
Someone who is not currently at work but who is available for work and who has actively looked for work in the last month.
Not in the Labor Force
Does not have a job and has not actively looked for work in the last month. Could either be not available for work (homemakers, retirees, etc) or available for work and either classified as a discouraged worker or not currently looking for work because of responsibilities or other problems.
Number of unemployed/Labor Force * 100
Labor Force Participation Rate
Labor Force/Working Age Population * 100
Employment Population Ratio
Employment/Working Age Population * 100
People who are available for work, but have not looked for a job during the previous four weeks because they believe no jobs are available for them. May understate or overstate employment, but more likely understate.
Short term unemployment that arises from the process of matching workers with jobs. Shortest term unemployment.
Unemployment that arises from a persistent mismatch between the skills and attributes of workers and the requirements of jobs. Longer term.
Unemployment caused by a business cycle recession.
All unemployment is due to frictional and structural factors. Therefore, there will always be some unemployment in the economy, usually 5-6%.
A firm owned by a single individual and not organized as a corporation. No legal distinction made between assets of the firm and owner. Limited ability to raise funds due to unlimited personal liability.
A firm owned jointly by two or more persons and not organized as a corporation. No legal distinction made between the assets of the firm and owners. Limited ability to raise funds due to unlimited personal liability.
A legal form of business that provides owners with protection from losing more than their investment, should the business fail. Owners have limited liability, shielding them from losing more than they have invested in the firm. Possible double taxation of income.
Anything of value owned by a person or firm.
Separation of Ownership from Control
A situation in a corporation in which the top management, rather than the shareholders, controls day-to-day operations.
A legal doctrine that gives corporations the rights conveyed to persons by the US Constitution and laws of Congress.
A problem caused by an agent pursuing his own interests rather than the interests of the principal who hired him.
A flow of funds from savers to borrowers through financial intermediaries such as banks. Intermediaries raise funds from savers to lend to firms (and other borrowers).
A form of direct finance, financial securities that represents a promise to repay a fixed amount of funds.
A form of direct finance, financial securities that represents partial ownership of a firm.
A summary of the firm's revenues, costs, and profit over a period of time- typically a 12-month fiscal year, which does not necessarily coincide with the calendar year.
Accounting Revenue Equation
Accounting Profit = Revenue - Explicit Costs
The highest valued alternative that must be given up to engage in some activity
The practice of purchasing loans, re-packing them, and selling them to the financial markets.
Using borrowed funds to purchase assets.
The value in today's dollars of funds to be paid or received in the future.
Present Value = Future Value(sub n)/(1+i)^n
n: years from now
i: interest rate
Value of a Stock
Stock Price = Dividend/(i - Growth Rate)
i: interest rate
Provides three key services: risk sharing, liquidity, and information.
Since we are assuming a closed economy where there is no international trade, when we use the equation Y = C + I + G + NX, we really mean Y = C + I + G, which can rearrange to
I = Y - C - G
S(private) = Y + TR - C - T
S(public) = T - G -TR
Y: factors of production
TR: Transfer payment
G: Government Spending
Two consecutive quarters of declining Real GDP.
Measures change in price level from one year to the next.
Increasing importance of services, establishment of unemployment insurance, active federal government stabilization policies, and increased stability of the financial system.
Aggregate Expenditure Model
A macroeconomic model that focuses on the short run relationship between total spending and real GDP, assuming that the price level is constant.
Total spending in the economy: the sum of consumption, planned investment, government purchases, and net exports.
AE = C + I + G + NX
I: Planned Investment (Actual Investment - Unplanned change in inventories)
G: Government Purchases
NX: Net Exports
Marginal Propensity to Consume
MPC = Change in Consumption/Change in Disposable Income
Marginal Propensity to Save
MPS = Change in Savings/Change in Disposable Income
Factors that Affect Level of Investment
Expectations of future profitability, interest rate, taxes, cash flow.
When Y increases, I increases and vice versa. Investment is highly procyclical.
When Real GDP rises by the amount of the increase of autonomous expenditure, it causes an increase in production, which causes an increase in Real GDP again, etc.
Multiplier Effect = Change in Real GDP/Change in Investment Spending
Formula for the Multiplier
Multiplier = Change in equilibrium Real GDP/Change in autonomous expenditure =
Aggregate Demand Curve
A curve that shows the relationship between the price level and the level of planned aggregate expenditure in the economy, holding constant all other factors that affect aggregate demand. Inverse relationship between price level and GDP, so downward sloping line (\)
Shifters- Consumption (C), Investment (I), Government Spending (G), Net Exports (NX), Money (M), Price Level (P)
Aggregate Demand and Aggregate Supply Model
A model that explains short run fluctuations in real GDP and the price level.
Short Run Aggregate Supply Curve
A curve that shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms. Upward sloping (/)
Shifters- Technology (A), Capital (K), Labor (L), Input Prices, Nominal Wage (W), Price Level (P)
Factors Affecting Labor Productivity Growth
Increases in capital per hour worked, technological change.
A change in the quantity of output a firm can produce using a given quantity of inputs.
The rate at which the capital stock declines due to either capital goods becoming worn out or becoming obsolete.
Arguments Against Economic Growth
Negative effects on the environment, depletion of natural resources, diminishment of distinctive cultures.
The relationship between the level of output of a good and the factors of production that are inputs to production.
Y = Af(K, L)
Stock of Capital
The total of all machines, equipment, and buildings in an entire economy.
Human effort, including both physical and mental effort, used to product goods and services.
The wage rate paid employees adjusted for changes in the price level.
Labor Demand Curve
A graph that illustrates the amount of labor that firms want to employ at each given wage rate.
Labor supply Curve
A graph that illustrates the amount of labor that households want to supply at each given wage rate.
Economic model that assumes wages and prices adjust freely to changes in demand and supply.
The level of output that results when the labor market is in equilibrium and the economy is producing at full-employment.
The downward rigidity of wages as an explanation for the existence of unemployment.
Social (Implicit) Contracts
Unspoken agreements between workers and firms that firms will not cut wages.
Relative-wage Explanation of Unemployment
An explanation for sticky wages (and therefore unemployment): If workers are concerned about their wages relative to other workers in other firms and industries, they may be unwilling to accept a wage cut unless they know that all other workers are receiving similar cuts.
Employment contracts that stipulate workers' wages, usually for a period of 1-3 years.
Contract provisions that tie wages to changes in the cost of living. The greater the inflation rate, the more wages are raised.
Efficiency Wage Theory
An explanation for unemployment that holds that the productivity of workers increases with wage rate. If this is so, firms may have an incentive to pay wages above the market-clearing rate.
Firms may not have enough information at their disposal to know what the market-clearing wage is.
Minimum Wage Laws
Laws that set a floor for wage rates, a minimum hourly rate for any kind of labor.
Long Run Aggregate Supply Curve
A curve that shows the relationship in the long run between the price level and the quantity of real GDP supplied.
Loanable Funds Model
-Curves- desired savings and desired investment
-Shifters of S- Income (Y), Consumption (C) (includes expected future income, disposable income, and wealth), Government Spending (G), Savings Rate (s), and Real Interest Rate (r).
-Shifters of I- expected future business profits, business taxes/regulations/subsidies, real interest rate (r).
-S is upward sloping, I is downward sloping
-Open economy means that there is trade between countries so there is Net Exports (S - I)
-Large economy- larger countries will affect the real world interest rate
-Trade deficit- r^c > r^w
-Trade surplus- r^w > r^c
-NX = S - I
Solow Growth Model
Depreciation/dilution line = (n+d)k
Per capita production function = y= A f(k)
savings rate * per capita production function = sy = sA f(k)
Technology (A), savings rate (s), depreciation (d), population growth rate (dilution) (n)
When one country's currency increases in value relative to another country's currency
When one country's currency's value decreases in value relative to another country's currency
Fixed Exchange Rate
Countries agree to keep the exchange rates between their currencies fixed for long periods.
Floating Exchange Rate
A country allows its currency's exchange rate to be determined by supply and demand. This adds an element of risk to foreign transactions, making it difficult for firms to make long term transactions with foreign countries.
Some countries keep their exchange rates fixed against other currencies, which enables easier planning for firms and helps to better fight inflation. This could lead to destabilizing speculation however and could cause difficulty in pursuing an independent monetary policy.
M1- currency in circulation and checking account deposits
M2- all M1 plus savings
Total (Actual) Reserves
Required Reserves + Excess Reserves
Excess Reserves are the only source of loans banks can give out
RR (required reserve ratio)- portion of money banks are required to keep and cannot loan out.
Simple Money Multiplier
1/Require Reserves Ratio
Goals of the Federal Reserve (and Monetary Policy)
1. Price Stability
2. High Employment
3. Stability of Financial Markets and Institutions
4. Economic Growth
Money vs Interest Rates
The Fed lowers interest rates on loans in order to stimulate people and businesses to borrow more
1/100 of a percent. Used to express percentage changes in costs or prices of bonds and securities, such as mortgage loans.
If people were to lose faith in banks and everyone wanted to withdraw their money at once. Federal Reserve can help prevent these by acting as a lender of last resort, promising to make loans to banks in order to pay depositors.
If many banks simultaneously experience bank runs
Open Market Operations
Buying and selling of previously issued Treasury securities by the Federal Reserve in order to control the money supply. Buy to increase money supply (more federal funds means they are cheaper, lower federal funds rate), sell securities to decrease.
No international trade, NX = 0
Expansionary Fiscal Policy
Essentially lowering interest rates. In a closed economy, this encourages investment, and consumption spending on durables. Expansionary monetary policy will increase aggregate demand by more in an open economy than in a closed economy. Also, the multiplier effect is lower, since some spending takes place on imported goods, which do not feed back in to real GDP. Therefore less effective in open economy.
Expansionary Monetary Policy
The Fed takes action to decrease real interest rates in order to increase real GDP. This occurs when short run equilibrium real GDP is below potential real GDP. This encourages increased employment. More effective in open economy.
Contractionary Monetary Policy
The Fed increases interest rates to reduce inflation, which will occur when the economy is producing above potential GDP and the Fed detects this to be a threat in the long run.
The Fed gives loans to banks at a discounted rate, encouraging banks to borrow, and therefore lend out, more money, increasing the money supply.
Buying securities beyond the normal short-term Treasury securities, including 10-year Treasury notes and mortgage-backed securities to keep their interest rates from rising to keep interest rates on mortgages low and to keep funds owing into the mortgage market in order to help stimulate demand for housing.
Zero lower bound, the Fed is unable to push rates any lower to encourage investment.
change in Y/change in T
Balanced Budget Multiplier
(change in Y/change in T) + (change in Y/change in G)
The economy will produce at this level in the long run (the LRAS level)
Free capital flows, independent monetary policy, fixed exchange rate. No country can have all three of these at the same time, so they must choose one to let go of.
Recommended textbook explanations
Principles of Economics
N. Gregory Mankiw
Essential Foundations of Economics
Michael Parkin, Robin Bade
Managerial Economics & Business Strategy
Jeff Prince, Michael Baye
Solutions Manual to Accompany Essentials of Investments
Alan J. Marcus, Alex Kane, Zvi Bodie
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