Chapter 10 Macro Econ

Recession

"A recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade."

An increase in corporate taxes

- Will shift the demand for loanable funds curve to the left (decrease the demand of firms) - Causing the real interest rate to decrease and investments to decrease

An increase in expected future profits

- Will shift the demand for loanable funds curve to the right (increase the demand of firms) -Causing the real interest rate to increase and investments to increase

An increase in the desire of households to consume today

- Will shift the supply of loanable funds curve to the left (decrease the supply) - Causing the real interest rate to increase and investment to decrease

An increase in the government's budget deficit

- Will shift the supply of loanable funds curve to the left (decrease the supply) - Causing the real interest rate to increase and investment to decrease

An increase in tax benefits for saving, such as 401(k) retirement accounts, which increase the incentive to save

- Will shift the supply of loanable funds curve to the right (increase the supply) -Causing the real interest rate to decrease and investment to increase

Increase the quantity of loanable funds?

An increase in the quantity of loanable funds means that both the quantity of saving by households and the quantity of investment by firms have increased.

Lower interest rate better or worse for firms?

Better because lower interest rates will make more investment options viable for the firm. The expected return on the investment can be lower and the project may still be viable if the firm can borrow at even lower interest rate.

Crowding out

By borrowing to finance its budget deficit, the government will have crowded out some firms that would otherwise have been able to borrow to finance investment Refers to a decline in private expenditures (in this case, investment spending) as a result of an increase in government purchases. Lower investment spending decreases the capital stock and the quantity of capital per hour worked.

Capital per hour​ worked:

Capital per hour​ worked: Refers to the manufactured goods that are used to produce other goods and​ services, such as​ computers, factory​ buildings, machine​ tools, and warehouses.

Are durable or nondurable goods more affected by the business cycle?

Durable goods

What does equilibrium determine?

Equilibrium in the market for loanable funds determines the quantity of loanable funds that will flow from lenders to borrowers each period. Equilibrium also determines the real interest rate that lenders will receive and that borrowers must pay.

Expansions and Recessions length since 1950s

Expansions have increased and recessions have decreased (except in the Great Recession)

Financial System

Financial system The system of financial markets and financial intermediaries through which firms acquire funds from households. The system shares the risk of​ lending, provides liquidity to​ savers, and collects and communicates information about borrowers.

Recession phase of business cycle

Following the business cycle peak, production, employment, and income decline

transfer payments (TR)

Households also receive income from government in the form of TR, which include Social Security payments and unemployment insurance payments.

Does inflation rate rise or fall during a recession?

Inflation rate peaks at the end of an expansion and then drops significantly in the recession

Inflation rate

Is the percentage increase in the price level from one year to the next We can measure the inflation rate as the percentage change in the CPI from one year to the next.

Why do service goods stabilize the economy?

Manufacturing production, particularly of durable goods such as automobiles, fluctuates more than the production of services because during a recession, households will cut back more on purchases of durables than they will on purchases of services. So, the increase in services as a percentage of GDP may have helped to stabilize the economy.

Financial markets

Markets where financial​ securities, such as stocks and​ bonds, are sold.

Price level

Measures the average prices of goods and services in the economy

Does real GDP measure economic growth?

No, real GDP does not, the percentage change in real GDP does measure the economic growth.

Rule of 70

Number of years to double= 70/Growth rate. For example: If real GDP per capita is growing at a rate of 5 percent per year, it will double in 70/5=14 years. If real GDP per capita is growing at a rate of 2 percent per year, it will double in 70/2=35 years.

Expansion phase of business cycle

Production, employment, and income are increasing.

When a governments run a deficit ...

Running a deficit has reduced the level of total saving in the economy and, by increasing the interest rate, has also reduced the level of investment spending by firms.

Public Savings is equal too:

S= T-G-TR G= government spending OR: S public = I - S private

Private savings is equal to:

S= Y + TR - C - T

Why is the U.S. economy relatively stable?

Shorter recessions, longer expansions, and less severe fluctuations in real GDP have resulted in a significant improvement in the economic well-being of Americans. 1. The increasing importance of services and the declining importance of goods. 2. The establishment of unemployment insurance and other government transfer programs that provide funds to the unemployed. The establishment of unemployment insurance and other government transfer programs that provide funds to the unemployed. 3. Active federal government policies to stabilize the economy. In the years since World War II, the federal government has actively used macroeconomic policy measures to try to end recessions and prolong expansions. Many economists believe that these government policies have played a key role in stabilizing the economy. 4. The increased stability of the financial system. Great Depression and Recession had severe instability within the banks, failing banks, and decrease in stock prices making it difficult for firms to sell stocks

The importance of small differences in growth rates

Small differences in growth rates can have large effects on how rapidly the standard of living in a country increases. Even small differences can accumulate to huge increase

Demand and Supply in the Loanable Funds Market

The demand for loanable funds is determined by the willingness of firms to borrow to engage in new investment projects, such as building new factories or carrying out research and development of new products. In determining whether to borrow, firms compare the return they expect to make on an investment with the interest rate they must pay to borrow the necessary funds. The demand for loanable funds is downward sloping because the lower the interest rate, the more investment projects firms can profitably undertake, and the greater the quantity of loanable funds they will demand.

The Market for Loanable Funds

The demand for loanable funds is determined by the willingness of firms to borrow to engage in new investment projects. The lower the interest rate the better as they pay a lower interest rate for taking out a loan. The lower the interest rate, the more investment projects firms can profitably undertake, and the greater the quantity of loanable funds they will demand. The supply of loanable funds is determined by the willingness of households to save and by the extent of government saving or dissaving. The higher the interest rate the better as they get more money back from savings. The higher the interest rate, the greater the reward for saving and the larger the amount of funds households will save. Equilibrium in the market for loanable funds determines the real interest rate and the quantity of loanable funds exchanged.

GDP GROWTH RATE

The growth rate of real GDP per capita for a particular year equals its percentage change from the previous year. The average annual growth rate provides the growth rate for longer periods of time.

Does the inflation rate rise or fall during a recession?

The inflation rate falls

Does the inflation rate rise or fall during a expansion?

The inflation rate rises, especially at the end of an expansion

Business cycle peak.

The period of expansion ends with a business cycle peak.

Business cycle trough

The recession comes to an end with a business cycle trough, after which another period of expansion begins.

Supply of loanable funds is determined by...

The supply of loanable funds is determined by the willingness of households to save and by the extent of government saving or dissaving. When households save, they reduce the amount of goods and services they can consume and enjoy today.

How to find growth rate and number of years doubled

To find growth rate use percentage change meaning Year 2-Year 1 / Year 1 x 100 = growth rate To find Number of years to double Rule of 70: 70/growth rate (percent NOT number)

S=I

We can conclude that total saving must equal total investment: S=I.

market for loanable funds

We can think of the financial system as being composed of many markets through which funds flow from lenders to borrowers: the market for certificates of deposit at banks, the market for stocks, the market for bonds, the market for mutual fund shares, and so on. In the loanable funds model, the interaction of borrowers and lenders determines the market interest rate and the quantity of loanable funds exchanged.

budget surplus

When the government spends less than it collects in taxes A higher level of saving results in a higher level of investment spending. Therefore, holding constant all other factors, there is a higher level of investment spending in the economy when there is a budget surplus than when there is a balanced budget.

budget deficit.

When the government spends more than it collects in taxes We can conclude that, holding constant all other factors, there is a lower level of investment spending in the economy when there is a budget deficit than when there is a balanced budget.

balanced budget.

When the government spends the same amount that it collects in taxes

real interest rate

corrects the nominal interest rate for the effect of inflation and is equal to the nominal interest rate minus the inflation rate.

Public saving (SPublic)

equals the amount of tax revenue the government retains after paying for government purchases and making transfer payments to households SPublic = T−G−TR.

Private saving

is equal to what households retain of their income after purchasing goods and services (C) and paying taxes (T). SPrivate = Y+TR−C−T. Y = GDP C = consumption

nominal interest rate

is the stated interest rate on a loan.

total saving in the economy (S) is equal to ...

the sum of private saving and public saving: S=SPrivate+SPublic, S=Y−C−G.

An increase in the real interest rate:

will cause a movement along the demand curve for loanable funds

The Business Cycle

1. As the economy nears the end of an expansion, interest rates are usually rising, and the wages of workers are usually increasing faster than prices. As a result of rising interest rates and wages, the profits of firms will be falling. Typically, toward the end of an expansion, both households and firms will have substantially increased their debts. These debts are the result of the borrowing that firms and households undertake to help finance their spending during the expansion. Rising debts can eventually lead households and firms to reduce their spending. 2. A recession will often begin with a decline in spending by firms on capital goods, such as machinery, equipment, new factories, and new office buildings, or by households on new houses and consumer durables, such as furniture and automobiles. As spending declines, firms that build houses and firms that sell capital goods and consumer durables will find their sales declining. As sales decline, firms cut back on production and begin to lay off workers. Rising unemployment and falling profits reduce income, which leads to further declines in spending. 3. As the recession continues, economic conditions eventually begin to improve. The declines in spending finally come to an end; households and firms begin to reduce their debts, thereby increasing their ability to spend; and interest rates decline, making it more likely that households and firms will borrow to finance new spending. Firms begin to increase their spending on capital goods as they anticipate the need for additional production during the next expansion. Increased spending by households on new houses and consumer durables and by businesses on capital goods will finally bring the recession to an end and begin the next expansion.

A government budget surplus

A budget surplus increases the total amount of saving in the economy, shifting the supply curve for loanable funds to the right. In the new equilibrium, the interest rate will be lower, and the quantity of loanable funds will be higher. We can conclude that a budget surplus increases the level of saving and investment.