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175 Cards in this Set
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- Back
- 3rd side (hint)
Figure 14.5 Suppose the economy is in short-run equilibrium above potential GDP, the unemployment rate is very low, and wages and prices are rising. Using the static AD-AS model, the correct Fed policy for this situation would be depicted as a movement from
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C to B
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Table 14-1 The hypothetical information in the table shows what the values for real GDP and price level will be in 2015 if the Fed does not use monetary policy. Which of the following policies makes sense if the Fed wants to keep real GDP at its potential level in 2015?
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The Fed should lower the target for the federal funds rate
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Which of the following would be classified as fiscal policy?
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------ The federal government cuts taxes to stimulate the economy
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The increase in the amount that the government collects in taxes when the economy expands and the decrease in the amount that the government collects in taxes when the economy goes into a recession is an example of
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Automatic stablizer
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The largest and fastest-growing category of federal government expenditures is
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transfer payment
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An increase in government purchases will increase aggregate demand because
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government expenditures are a component of aggregate demand
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Expansionary fiscal policy involves
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increasing government purchases or decreasing taxes
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Figure 15-1 An increase in taxes would be depicted as a movement from
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using the static AD-AS model ------ B to A
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Figure 15-1 Suppose the economy is in short-run equilibrium below potential GDP and Congress and the president lower taxes to move the economy back to long-run equilibrium. Using the static AD-AS , this would be depicted as movement from
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------ A to B
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Figure 15-1 Suppose the economy is in short-run equilibrium below potential GDP and no fiscal or monetary policy is pursued. Using the static AD-AS model, this would be depicted as a movement from
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A to E
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If real GDP exceeded potential real GDP and inflation was increasing, which of the following would be an appropriate fiscal policy?
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An increase in taxes
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Figure 15-3 In the dynamic model of AD-AS, if the economy is at point A in year 1 and it is expected to go to point B in year 2, Congress and the president would most likely
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Increase taxes
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The multiplier effect refers to the series of
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induced increases in consumption spending that result from an initial increase in autonomous expenditures
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A change in consumption spending caused by income changes is ______ change in spending, and a change in government spending that occurs to improve roads and bridges is _____ change in spending.
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an induced; an autonomous
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Which of the following would increase the size of the government purchases multiplier?
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a decrease in the amount saved by households from an increase in income
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If the tax multiplier is -1.5 and a $200 billion tax increase is implemented, what is the change in GDP, holding everything else constant? (Assume the price level stays constant.)
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------ a $300 billion decrease in GDP
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Suppose the government spending multiplier is 2. The federal government cuts spending by $40 billion. What is the change in GDP if the price level is not held constant?
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------ a decrease of less than $80 billion
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Suppose Congress increased spending by $100 billion and raised taxes by $100 billion to keep the budget balanced. What will happen to real equilibrium GDP?
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Real equilibrium GDP will rise
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An economic expansion tends to cause the federal budget deficit to _____ because tax revenues _______ and government spending on transfer payments ________.
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------ decrease; rise; falls
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Which of the following is a reason why we should consider the federal national debt a problem?
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------ If the debt drives up interest rates, crowding will occur.
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What is the fundamental macro equation?
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Y= C + I + G + NX
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Which of the following best describes supply-side economics
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Tax rates, particularly marginal tax rates, affect the incentive to work, save, and invest, and therefore, aggregate supply
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Which of the following is considered a weakness of the flat tax?
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------ The distribution of income would be more unequal under the tax
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According to the short-run Phillips curve, the unemployment rate and the inflation rate are
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------ negatively related
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Figure 16-1 What should the Federal Reserve do if it wants to move from point A to point B in the short-run Phillips curve depicted in the figure above?
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sell treasury bills
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Figure 16-1 Suppose that the economy is currently at point A. If the Federal Reserve engaged in contradictory monetary policy, where would the economy end up in the short run?
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point B
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16-1 Suppose that the economy is currently at point A, and the unemployment rate at A is the natural rate. What policy would the Federal Reserve pursue if it wanted the economy to move to point B in the long run?
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No policy will move the economy to point B in the long run
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According to the short-run Phillips curve, if unemployment is 3.2% and inflation is 1.3% an increase in the inflation rate might result in which of the following?
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------ a decrease in the unemployment rate to 3.0%
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Figure 15-3 In the dynamic model of AD-AS, if the economy is at point A in year 1 and is expected to go to point B in year 2, and no fiscal or monetary policy is pursued, then at point B
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The unemployment rate is very low
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Figure 15-1 Suppose the economy is in short-run equilibrium above potential GDP and automatic stabilizers move the economy back to long-run equilibrium. Using the static AD-AS, this would be depicted as a movement from
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C to B
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What is the natural rate of unemployment?
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the unemployment rate that exists when the economy is at potential GDP
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Matt's real wage in 2010 is $26.80. If the price level is 104, what is Matt's nominal wage?
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------ $27.87
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Figure 16-2 Suppose the economy is at point B in the figure above. Which of the following is true?
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The expected rate of inflation is 3%
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Figure 16-2 Suppose the economy is at point C. If the Fed decreases the money supply so that inflation falls, the economy will ________ in the long run, holding all else constant.
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eventually move to point A
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If actual inflation is greater than expected inflation, what is the relationship between the actual real wage and the expected real wage?
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The actual real wage will be lower than the expected real wage.
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If firms and workers have rational expectations, including knowledge of the policy being used by the Federal Reserve
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expansionary monetary policy is ineffective
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If wages and prices adjust slowly, we would expect expansionary monetary policy to be -
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more likely to affect the unemployment rate
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Models that focus on factors such as technology shocks rather than "monetary" explanations of
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real business cycle modes
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Which of the following would be the source of a "real" business cycle?
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changes in technology
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Some economists argue that the short-run Phillips curve is not vertical, and that the monetary policy can be effective in the short run. Which one of the following is not one of the reasons for this skepticism?
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Empirical evidence shows workers and firms have rational expectations
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Figure 16-2 Suppose the economy is at point A. The Fed uses expansionary monetary policy to lower the unemployment rate permanently below the level associated with A. Which of the following will occur?
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------ Inflation will accelerate in the long run
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Figure 16-2 At which point is the unemployment rate equal to the natural rate of unemployment?
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A
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Figure 16-2 Suppose the economy is at point A in the figure above. Which of the following is true?
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------ The current unemployment rate is equal to the natural rate of unemployment
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16-2 Suppose the economy is at point C. If workers adjust their expectations of inflation, which of the following will be true?
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------ The short-run Phillips curve will shift to the left
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Figure 16-2 Suppose the economy is at point A in the figure above. Which of the following is true?
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Actual inflation and expected inflation are the same
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What is transfer payment?
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social security, it's not included in GDP
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What are the 3 types of investment?
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1. Business fixed investment (building)
2. Residential (housing) 3. Business inventories Stocks or rare coins |
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What happen in the long run when there's an increase in saving?
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saving can help the economy grow b/c there's more $ to borrow
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What is GDP?
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Goods + services produced within a country in a year.
Include market value of final goods Only includes current production Financial assets are not GDP b/c they don't produce anything |
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What GDP won't include?
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1. Household production
2. Underground econ |
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What are the shortcomings of GDP as a measure of well-being?
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1. Value of leisure not included in gdp
2. Not adjusted for population 3. Not adjust for changes in crimes 4. Good/services not equally distributed |
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What is real GDP?
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Value of goods + services calculated @ base year prices or at constant price level
Takes inflation into account |
real GDP may be a better measure b/c it holds prices constant
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Nominal GDP
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Value of final goods & services evaluated @ current year price level
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How to calculate Real GDP
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P of 1 (2009) x Q1(2009) + P of 2(2009) x Q of 2 (2009)
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What is the equation for Nominal GDP
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Real GDP x Price level
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GDP deflator
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Nominal GDP/Real GDP x 100
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Calculating inflation b/w 2 years using GDP deflator
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GDP deflator in later yr- GDP deflator in earlier yr/ GDP earlier x 100
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What is potential GDP
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Level of real GDP attained when all firms are producing at capacity --> what would have been if all factors of production (labor & capital) had been used at their normal rates
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What is inflation
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Percent increase in price level from one year to the next
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Difference b/w CPI & GDP deflator
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CPI includes only goods bought by consumers + imported goods
GDP deflator--> includes ALL goods Only domestic goods |
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CPI formula
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Expenditures in current year/ Expenditures in base year x 100
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Inflation rate formula. In other words, to show how much CPI changes over the year
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CPI current - CPI previous/CPI base x 100
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Name reasons why CPI may overstate inflation
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1. Substitution bias--> doesn't reflect that consumers can substitute the goods
2. Increase in quality bias--> over time product quality increase --> price increase not just b/c of pure inflation 3. New product bias --> CPI doesn't include new product 4. Outlet bias--> consumers buy products online --> discount and cheaper |
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What is Nominal interest rate? State the formula
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Stated interest loan
i = r + pi (inflation) If forecasting using expected inflation rate bank wants r= 5%, but expected inflation is 3%, so it will set at 8% |
Price level goes up, interest rates goes up
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Real interest rate
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adjust for inflation
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Inflation rate goes up, expected inflation rate will go up
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Growth rate of real GDP or real GDP/capita
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GDP current yr- GDP previous yr/ GDP pre yr x100
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Calculation of growth rate & rule of 70
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# of year to double = 70/growth rate
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What determines the rate of long run growth? (GDP/per capita)
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1. Labor productivity--> quantity of goods + services that can be produced by one worker or by one hr of work
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What causes labor productivity to increase?
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1. Quantity of capital/hr worked
2. Level of tech |
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Increase in capital/hr worked
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Capital--> goods + equipment used to produce other goods + services
Human capital--> accumulated knowledge & skills |
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Tech change
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Is an increase in quantity of outputs firms can produce using a given quantity of inputs
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What determines how fast econ grow?
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1. Better machines & equipment
2. Increase in human capital 3. Better means of organizing & managing production |
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Calculate unemployment rate
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# unemployed/labor force (unemployed + employed) x100
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Labor force participating rate
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labor force/ working-age population
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What is the effect of min, wage law on unemployment?
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Fairly small
But only cause higher unemployment rate b/c if set above the market rate determined by demand + supply of labor --> quantity of labor supplied will be greater than demand |
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Efficiency wages
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Quantity of labor supplied > dmeand
leads to unemployment, just like min. wage laws + unions |
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Diminish return to capital
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Increase in the quantity of capital/hr worked will result in diminishing output/hr worked
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Fundamental concept of per worker function
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each additional increase in captal/hr worked will result in smaller increase in output/hr worked
So at very high lvl of capital/hr worked, further increase will not result in any increase in real GDP/hr work |
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Tech change
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In the long run, a country will experience an increasing standard of living only if it experiences continuing tech change
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What is the fundamental macro equation?
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GDP = Aggregate expenditure
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Consumption
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Is a component of GDP, spending by household on goods + services with the exception of purchases of new housings (which is investment)
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Government purchases
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Does not include transfer payments
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Net exports
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Exports - Imports
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What is the aggregate demand curve?
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Relates Price level to Aggregate Expenditures on economy
s goods + services For every possible price level, it shows the total level of aggregate expenditure in the economy |
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Price level
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a measure of the overall price level (GDP deflator or CPI)
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Aggregate expenditure
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is a POINT ON an aggregate demand curve
So the AD Curve shows what AE will be at EVERY price level |
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Increase in AE
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is a movement ALONG the AD Curve
It moves down the AD curve at a lower P, which makes sense b/c decrease in price will increase in expenditures (or spending) P goes up, Y goes down |
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A decrease in AE
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Is a movement (up) along the AD curve
P goes up, Y goes down It is an inverse r/s |
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Why does AD slope down? Why is it when P goes up, AE goes down? and when P goes down AE goes up?
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1. Wealth effect (Consumption function)
2. Interest rate effect 3. International trade effect |
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What is consumption function?
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C= f((Y-T), (Y-T)^e, r, Wealth, Price level)
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Consumption function component: wealth effect
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The wealth effect
When P increase, the Purchasing power of household wealth decreases, which leads to a decrease in consumption (people buy less stuff when price goes up) and ultimately leads to decrease in AE |
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Consumption function: Why does an increase in P cause an increase in the interest rate (r)?
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When r goes up, people have more incentive to save money (b/c it's costly to buy cars + it's more profitable to put their $ in the bank and get the extra interest) and it costs more to borrow. This will lead to a decrease in consumption
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Investment function (component of GDP)
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I = f(r, Y, Ye, tax policy)
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NPV of Investment
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= (PDV of Project Revenues) - (PDV of Project Costs)
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What is the effect of an increase in interest rate on Investment?
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When interest rate goes up, there are fewer investement projects w/ NPV > 0
It also costs more to borrow to finance investment So Investment goes down |
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What is the Interest Rate Effect?
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When Price goes up, Interet rate goes up, leads to decrease in both Consumption & ,Investment,
Net Exports. Ultimately leads to decrease in AE |
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Real Exchange Rate
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Real exchange rate = e = P^domestic x E (nominal exchange rate) /P foreign
Therefore, e will change if Pdom changes Pdom increase (relative to Pfor) will lead to increase of e, which will leads to a decrease of exports & increase of imports Since NX = X-IM the overall NX will decrease |
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International trade effect
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Increase in P, leads to increase in e, which leads to decrease in NX and this will leads to decrease in AE
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Increase in AD
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Increase in AD --> AD curve will move rightward or upward
Decrease in AD--> AD curve move leftward or inward |
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What could shift the AD curve?
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1. Gov policies
2. Changes in Expectations of Households & Firms 3. Changes in foreign variables |
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Gov policies & AD Curve
Monetary policies |
--are policies that affect r, this is done by the FED
When FED increase r--> C decrease, I decrease, NX decrease-->AD shifts left (AD decreases) On the other hand, when FED decreases r, C + I + NX (all is function of AD)--> AD will shift right |
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What is monetary policy?
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actions which increases $ supply
i.e when FED buys bonds |
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Change in Total Deposits Function
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1/(R+E) x Initial Change in Reserves
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Money supply
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Change in Total Deposits + Change in Cash Held By the Public
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What is the Interest Rate Effect?
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When Price goes up, Interet rate goes up, leads to decrease in both Consumption & ,Investment,
Net Exports. Ultimately leads to decrease in AE |
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What is the effect of an increase in Interest Rates on Net Exports?
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edit later
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Real Exchange Rate
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Real exchange rate = e = P^domestic x E (nominal exchange rate) /P foreign
Therefore, e will change if Pdom changes Pdom increase (relative to Pfor) will lead to increase of e, which will leads to a decrease of exports & increase of imports Since NX = X-IM the overall NX will decrease |
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International trade effect
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Increase in P, leads to increase in e, which leads to decrease in NX and this will leads to decrease in AE
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Increase in AD
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Increase in AD --> AD curve will move rightward or upward
Decrease in AD--> AD curve move leftward or inward |
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What could shift the AD curve?
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1. Gov policies
2. Changes in Expectations of Households & Firms 3. Changes in foreign variables |
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Gov policies & AD Curve
Monetary policies |
--are policies that affect r, this is done by the FED
When FED increase r--> C decrease, I decrease, NX decrease-->AD shifts left (AD decreases) On the other hand, when FED decreases r, C + I + NX (all is function of AD)--> AD will shift right |
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What is monetary policy?
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actions which increases $ supply
i.e when FED buys bonds |
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Change in Total Deposits Function
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1/(R+E) x Initial Change in Reserves
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Money supply
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Change in Total Deposits + Change in Cash Held By the Public
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Describe in a graph, equlibrium in the Money Market. What if the FED buys bonds?
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Draw it
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Contractionary Monetary Policy
Give example & graph |
actions which decreases the $ supply
i.e when FED sells bonds |
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What is the economic consequences of FED actions? When FED buys bonds
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When FED buys bonds, i goes down, r goes down --> C + I + NX goes up
--> AD goes up and so the AD Curve shifts up or right |
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What are fiscal policies
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policies which affect G and/or T done by Congress/White Hosue/Treasury Dept
G goes up, AD shifts right G goes down, AD shifts left So when Congress raises T --> C goes down, I goes down and AD shifts to the left When T decreases, I goes up, C up--> AD shifts right |
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What could shift the AD curve? Changes in expectation of household & firms
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(Y-T)^e from C function
(Y-T)^e (expectation) goes up--> people will spend more--> increase in C--> AD shifts right But when expectation decreases--> C goes down and AD shifts left In the I function (Y^e) If Y^e increase, I will increase --> AD shifts right |
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Changes in Foreign Variables
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the NX in Y function
NY= f(e, Yfor, Ydom, Tastes, Trade policies) E goes up, e goes up, NX goes down---> AD will shift left Ydom goes up, IM goes up -->NX goes down and AD shift left But when Yfor goes up--->X goes up--->NX goes up --> AD shifts right |
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Draw a graph describing an increase in AD
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when r goes down --> C goes up, I up, NX up ---> AD shifts right
G goes up & T goes down---> AD shifts right |
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Government Spending Multiplier
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1/(1-Cy)
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Tax multiplier
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is the negative of Gov Multi
-Cy/(1Cy) |
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Expansionary Fiscal Policy
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is when G increase, Taxes decrease, and/or Transfer Payment increase
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Federal Funds rate
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is the interest rate banks charge each other for short-term loans of reserves
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What determines the slope of the SRAS Curve?
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When SRAS Curve is steep --> most prices are flexible. Flat is sticky
So the ans is the degree of how sticky/flex prices are in an economy |
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What might cause the SRAS Curve to shift?
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1. Negative Supply Shock will cause SRAS to shift left (lower)
2. Positive Supply Shock will cause SRAS curve to shift right |
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Calculating the current price of a past price
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Value in time t + n dollars = (Values in time t dollars) (P t+n (current)/Pt (past))
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Quantity Equation
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Velocity (of M1) = Nominal GDP/M1 Money Stock
V= P x Y/M MV = PY Growth rates form: %changeM + %changeV = %changeP + %changeY |
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What are the 2 assumptions that turn the Quantity Equation into the Quantity Theory?
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1) In the long run, %changeV = 0
2) In the long run, %changeM does NOT affect %changeY |
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Quantity Theory of Money
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From the 2 assumptions
%changeP = %changeM - %changeY |
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Why would we expect convergence?
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1) Tech transfer
2) Poorer countries can attract more capital |
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To raise K/L --> productivty,wages, living standard, what else can gov also encourage?
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1) Foreign direct investment: capital investment, owned & operated by foreign entity
2) Foreign portfolio investment: capital investment financied w/ foreign $ but operated by domestic residents |
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What are the 3 major approaches to Development?
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1) Environmental approach (geography, climate, disease,inaccessibility to trade routes, lack of natural resources)
2) International Trade Approach 2 dimensions of integration into worlkd economy (a. trade in goods & services, b. capital inflows) 3. Institutional Approach legal & political system, corruption |
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If $ growth does not affect real GDP, V is stable, an increase in money supply creates proportional increase in
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both price level & nominal GDP
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What is budget balance?
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T (gov revenue) - (G + TR) which are gov expendatures
When T > (G + TR) ---> Budget surplus T < (G + TR) ---> budget deficits T = (G + TR) --> a balanced budget |
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Federal debt
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total of accumulated deficits
= total amount owned by govt |
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Describe economy is in LR E when expansionary fiscal policy is undertaken
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move from E1 (AD0) to E2 at SRAS on AD2 (rightward shift). There is an inflationary gap as P1 moves to P2
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Describe economy is in recession when expansionary fiscal policy is undertaken
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E1(on LR) on AD0 moves to AD1 (a rightward shift) until it intersects LRAS at E2. As P1-->P2, there is a recessionary gap
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Explain how a change in i causes a change in the q of $ demanded
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With an increase in i, there is a smaller quantity of money demanded
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How money demanded also depends on nominal gdp (p x y)
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an increase in nominal gdp shifts Md to the right
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SR Effects of Expansionary Fiscal Policy
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higher i leads to crowding out of investment
i up --> r up ---> C, I, NX down, AD curve ends up left of where it would have been after expan fiscal policy if there were no crowding out |
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Supply & demand in loanable funds market
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Private saving + Public saving = Investment + NFI
S + T-(G+TR) = I + NFI at E |
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Decrease in supply of loanable funds due to expan policy
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the supply curve shifts left and a decrease in supply --> increase in in equil r + decrease in equil Q
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Automatic stabilizers
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programs which tend to stabilize demand by expanding or shrinking w/ the econ w/o any additional legis action
ex: progressive income tax unemployment compen welfare payment food stamps |
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Money multiplier
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1/ R + E, R= reserve requirement
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long run phillips curve
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According to Friedman and Phelps, there is no trade-off between inflation and unemployment in the long run. Growth in the money supply determines the inflation rate. Regardless of the inflation rate, the unemployment rate gravitates toward its natural rate. As a result, the long-run Phillips curve is vertical.
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How Does a Vertical Long-Run Phillips Curve Affect Monetary Policy?
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The inflation rate is stable only if the unemployment rate equals the natural rate of unemployment (point C).
If the unemployment rate is below the natural rate (point A), the inflation rate increases, and, eventually, the short-run Phillips curve shifts up. If the unemployment rate is above the natural rate (point B), the inflation rate decreases, and, eventually, the short-run Phillips curve shifts down. |
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LR Effects of Monetary Policy
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In the Long Run, Monetary Policy only affects the price level
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Functions of Money
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Medium of Exchange
Store of Value Unit of Account |
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M1
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Currency and Traveler’s Checks
Cash in the hands of the public Checking Deposits Held at commercial banks, S & Ls, Savings Banks, and Credit Unions |
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M2
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M1
Savings deposits Time deposits Money market mutual funds and other deposits |
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Recessionary Gap
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YActual < YPotential
Price Level Goes Down Unemployment > Natural Rate |
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Inflationary Gap
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YActual > YPotential
Price Level Goes Up Unemployment < Natural Rate |
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sr pc
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Monetary policy can reduce u-rate below the natural u-rate by making inflation greater than expected
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lr pc
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Expectations catch up to reality, the unemployment rate goes back to natural rate, whether inflation is high or low
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nairu
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The unemployment rate at which the inflation rate has no tendency to increase or decrease.
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Balance of Payments
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The record of a country’s trade with other countries in goods, services, and assets.
Current Account Financial Account |
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Current Account
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trade in goods and services
≈ X – IM ≈ Net Exports (NX) |
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Financila Account
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= trade in assets
= Capital coming in – capital leaving = Net Capital Flows |
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Relationship Between Current Account and Financial Account
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Current Account = − Financial Account
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Net Foreign Investment is another measure of the imbalance in a country’s trade in assets:
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When Net Foreign Investment > 0, domestic purchases of foreign assets exceed foreign purchases of domestic assets.
When Net Foreign Investment < 0, foreign purchases of domestic assets exceed domestic purchases of foreign assets. |
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Variables that Influence Net Foreign Investment
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Real interest rates paid on foreign assets
Real interest rates paid on domestic assets Perceived risks of holding foreign assets Govt policies affecting foreign ownership of domestic assets |
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The Equality of NXand Net Foreign Investment (NFI)
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An accounting identity: NFI = NX
arises because every transaction that affects NX also affects NFI by the same amount (and vice versa) When a foreigner purchases a good from the U.S., U.S. exports and NX increase the foreigner pays with currency or assets, so the U.S. acquires some foreign assets, causing NFI to rise. When a U.S. citizen buys foreign goods, U.S. imports rise, NX falls the U.S. buyer pays with U.S. dollars or assets, so the other country acquires U.S. assets, causing U.S. NFI to fall. |
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SavingPrivate
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Y + TR - (C +T)
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SavingPublic
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T-G-TR
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National Saving
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S = Y − C − G
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What does export depend on
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Real exchange rate (e)
GDP of our trading partners (YFor) Tastes and preferences of people abroad for our goods and services Trade policies = f (e, YFor, Tastes, Trade Policies) e↑ X↓ e↓ X↑ YFor↑ X↑ YFor↓ X↓ |
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What do imports depend on?
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Real exchange rate (e)
Domestic GDP (YDom) Domestic tastes and preferences for foreign goods Trade policies IM = f (e, YDom, Tastes, Trade Policies) e goes up, IM goes up; e goes down IM down |
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Nx
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e↑ X↓, IM↑ (X – IM)↓ NX↓
e↓ X↑, IM↓ (X – IM)↑ NX↑ YFor↑ X↑ (X – IM)↑ NX↑ YFor↓ X↓ (X – IM)↓ NX↓ |
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Nominal Exchange Rate
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– price of one currency in terms of another currency
= number of units of foreign currency per unit of domestic currency |
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Real Exchange Rate
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the price of goods in one country in terms of the price of goods in some other country
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Purchasing Power Parity
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E should be such that e = 1
e = e = 1 E = Pfor/Pdomest If e > 1, then E is too high, i.e., the foreign currency is undervalued relative to the domestic currency If E is at the PPP level, e = 1 If e < 1, then E is too low, i.e., the foreign currency is overvalued relative to the domestic currency |
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Determinants of I
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Expectations of future profitability
Optimism or pessimism Taxes Corporate income tax Investment tax incentives Cash flow Real interest rate |
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Marginal propensity to save (MPS)
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The change in saving divided by
the change in disposable income. |
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