econ 104 exam 3

avg GDP per capita from 1000000 BCE to 1300 CE was

$150 per year

what can shift SRAS?

- increases in the labor force and the capital stock -technological change - expected changes to future price level (expecting the price level to increase leads workers and firms to increase wages and prices) -unexpected changes in the price of an input (oil) -- SUPPLY SHOCK

things that cause movements along the aggregate demand curve

- the wealth effect - when the price level rises, the real value of household wealth declines, and so will consumption, thereby reducing quantity demanded; when the price level falls, the real value of household wealth rises, and so will consumption and quantity demanded -the interest rate effect - a higher price level will increase the interest rate and reduce investment spending, reducing quantity demanded; a lower price level will decrease the interest rate and increase investment spending, increasing quantity demanded - the international trade effect - if the US price level rises relative to other price levels, US exports become relatively more expensive, and US exports will fall, causing net exports to fall, thereby reducing quantity demanded; a lower US price level relative to others has the opposite effect, causing net exports to rise, thereby increasing quantity demanded

paul romer believes

-accumulation of knowledge capital is a key determinant of economic growth -but increases in knowledge capital are subject to diminishing returns at the firm level -at the level of the entire economy, though, knowledge capital is subject to increasing returns (bc knowledge becomes available to everyone)

shifts in the SRAS

-an increase in the labor force or capital stock shifts SRAS right -an increase in productivity shifts SRAS right -an increase in the future expected price level shifts SRAS left bc expecting the price level to increase leads workers and firms to increase wages and prices -an increase in workers and firms adjusting to having previously underestimated the price level shifts SRAS left bc workers and firms attempt to catch up to a higher price level by increasing wages and prices -an increase in the price of an important natural resource shifts SRAS left bc costs of producing output rise

what determines the level of consumption?

-current disposable income -household wealth -expected future income -price level -interest rate

the keys to higher living standards

-establish the rule of law -provide education & healthcare for the population -increase the amount of capital per hour worked -adopt the best technology (foreign direct investment) -participate in the global economy

what determines the level of investment?

-expectations of future profitability (animal spirits) -interest rate (higher i - less investment, lower i - more investment) -taxes on firms -cash flow (the difference between the cash revenues received by a firm and the cash spending by a firm)

the unemployment rate tends to stay low even after a recession has ended bc

-firms are reluctant to hire new employees during the early stages of recovery -also employment often rises slower than population growth -and some firms continue to operate below their capacity even after a recession has ended

policies the government could enact to help shift the LRAS curve right

-increase education -increase research & development -increase healthcare -increase resources

what causes movements along the aggregate demand curve

-interest rate effect -international trade effect -wealth effect

what determines net exports?

-price level in US relative to other countries (if US inflation is higher than other countries', demand for US products relatively falls so net exports fall and vice versa) -growth rate in US relative to other countries (when US income rises faster than foreign incomes, US consumers buy more foreign products than foreign consumers buy our products so net exports fall and vice versa) -strength of dollar relative to other countries (an increase in the value of the dollar will reduce exports and increase imports, so net exports will fall, and vice versa)

government policy can help increase the accumulation of knowledge capital in 3 ways

-protecting intellectual property rights w patents and copyrights -supporting research & development -subsidizing education

if the real interest rate increases, what will happen to net exports?

-real interest rate goes up -demand for country's bonds or financial investments goes up -demand for country's currency goes up -country's currency inflates -imports increase, exports decrease -net exports decrease

some economists predict that we may soon enter a period of extended slow growth, or secular stagnation bc of

-slowing population growth in the US will reduce the demand for housing -modern IT firms require much less capital than older industrial firms -the price of capital goods (computers) have been falling relative to other prices

loanable funds diagram

-technological change increases the demand for loanable funds -if the gov runs a deficit, supply shifts left (the gov will crowd out some firms that otherwise could have borrowed) -a budget surplus shifts supply to the right

the short run aggregate supply curve is upward sloping bc

-wage price stickiness -menu costs -slow wage adjustment by firms aka -firms and workers fail to predict changes in the price level -prices of final goods rise more quickly than prices of inputs

the consumption function and the 45 degree line

-whenever spending is greater than production, firms' inventories fall. -the fall in inventories is equal to the vertical distance between the AE line and the 45 degree line -whenever production is greater than spending, firms' inventories rise. -the difference in inventories is equal to the vertical distance between the AE line and the 45 degree line

rule of 70

Doubling time (in years) = 70/(percentage growth rate).

Why do economic growth rates​ matter?

High levels of sustained economic growth reduce infant mortality. When a country sustains high growth​ rates, life expectancy at birth increases. High growth rates coincide with improved living standards.

more shifts in SRAS

If menu costs were​ eliminated, the​ short-run aggregate supply curve will beThe SRAS curve will shift to the right if there is an increase in the labor force or capital accumulation The SRAS curve will shift to the right if there is an increase in productivity The SRAS curve will shift to the right if there is a technological change The SRAS curve will shift to the left if there is an increase in the expected price of an important natural resource The SRAS curve will shift to the left if there is an increase in the adjustment of workers' and firms' prior underestimation of the price level The SRAS curve will shift to the left if there is an increase in expected future prices

cities on first slide from lesson 7

Kabul and Singapore

the new growth theory differs from Solow's growth theory since

Solow's growth theory focuses on technological change and the quantity of capital available to workers whereas the new growth theory states that accumulation of knowledge capital is a key determinant of economic growth

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 in the long run, changes in the price level do not affect the level of real GDP- so LRAS is just GDP (a straight line up) changes in price cause a movement along changes in anything else cause a shift (capital stock, technology, institutions like property rights or economic incentives) LRAS shifts to the right each year as the number of workers in the economy increases, more machinery and equipment are accumulated, and technological change occurs

financial security

a document that states the terms under which funds pass from the buyer of the security to the seller

new growth theory (aka endogenous growth theory) developed by paul romer

a model of long-run economic growth that emphasizes that technological change is influenced by economic incentives and so is determined by the working of the market system focuses on the accumulation of knowledge capital (or ideas) as a key component of economic growth knowledge capital is subject to increasing returns states that firms will add to an​ economy's stock of knowledge capital by engaging in research and development or by contributing to technological change.

aggregate demand aggregate supply model

a model that explains short-run fluctuations in real GDP and the price level demand: variables that impact price level cause movements along the aggregate demand line variables that impact anything else cause shifts in aggregate demand supply: -there are 2 types, short run (when things havent adjusted yet) and long run (when things have completely adjusted)

recession

a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.

planned investment - the planned spending by firms (included in AE)

actual investment - the actual spending by firms (included in GDP)

If inventories decline by more than analysts predict they will decline, this implies that

actual investment spending was less than planned investment spending

graph axes

aggregate expenditure: vertical-AE horizontal-GDP aggregate demand aggregate supply vertical-P horizontal-GDP

shifts in the loanable funds model

an increase in the govs budget deficit will shift supply to the left an increase in the desire of households to consume today will shift supply to the left an increase in tax benefits for saving will shift supply to the right an increase in expected future profits will shift demand to the right an increase in corporate taxes will shift demand to the left

usually at the beginning of a recession inventories rise

and at the beginning of an expansion inventories fall

business cycle characteristics

at the end of an expansion: -interest rates rising -wages of workers rising faster than prices -firms' profits falling -everyones in debt recessions begin: -with a decline in spending on capital and durable goods -spending declines and so sales decline -firms lay off workers -unemployment rises and profits fall later on in the recession: -declines in spending end -households and firms reduce debt -interest rates decline -firms increase spending on capital as they anticipate the next expansion

budget deficit - spending > saving

budget surplus - more tax revenue than spending

solow contributed the idea that technology is necessary for economic growth

but romer actually figured out how to mathematically prove the impact of technological innovations

the economic growth model predicts that poor countries will grow faster than rich countries

but we dont really see this catch up happening in all cases why havent most western european countries, canada, and japan caught up to the US? -the greater flexibility of US labor markets -the greater efficiency of the US financial system why dont more low income countries experience rapid growth? -failure to enforce the rule of law -wars & revolutions -poor public education and health -low rates of saving and investment

how can gov policies, holding all else constant, shift the AD curve to the right?

by increasing gov purchases

things that shift the aggregate demand curve

changes in gov policies: (monetary policy) -lower interest rates shift aggregate demand to the right -higher interest rates shift aggregate demand to the left (fiscal policy) -an increase in gov purchases shifts the aggregate demand curve to the right, and a decrease in gov purchases shifts the aggregate demand curve to the left -an increase in personal income taxes shifts AD left, a decrease in personal income taxes shifts AD right -an increase in business taxes shifts AD to the left, a decrease in business taxes shifts AD to the right changes in the expectations of households & firms: -if households become more optimistic about future incomes, AD shifts right -if they become less optimistic, AD shifts left changes in foreign variables: -if US GDP grows faster than other GDPs, aggregate demand curve will shift left -if the exchange rate between the dollar and the currencies rises, AD shifts left -a decrease in net exports shifts AD to the left -an increase in net exports at every price level will shift AD to the right -net exports will increase if GDP grows slower in the US than elsewhere -net exports will increase if the value of the dollar falls

The​ long-run aggregate supply curve is vertical because in the long​ run,

changes in the price level do not affect potential​ GDP, as potential GDP depends on the size of the labor​ force, capital​ stock, and technology.

in 1936 john maynard keynes published a book that identified 4 components of AE that together equal GDP

consumption, planned investment, gov purchases, net exports

Compared to the U.S. aggregate demand​ curve, the reason that the demand curve for an individual​ product, such as​ bananas, slopes downward is

different, because consumers can substitute between individual products.

toward the end of an expansion, the inflation rate begins to rise

during recessions, the inflation rate declines

John Green video

education increases overall economic growth

the financial system is comprised of

financial markets - markets where stocks, bonds, etc are traded and financial intermediaries - firms like banks, insurance companies etc that borrow funds from savers and lend them to borrowers

monetary policy is actions the fed takes to manage the money supply and interest rates

fiscal policy is changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives

the Solow growth model

focuses heavily on technological change and its effect on long run economic growth said that productivity growth is the key factor in explaining long run growth rob solow won a nobel for it

one way for a developing country to break out of the vicious cycle of low saving and investment and low growth is through foreign investment

foreign direct investment - the purchase or building by a firm of a facility in a foreign country foreign portfolio investment - the purchase by an individual or a firm of stocks or bonds issued in another country these types of investment can give low income countries access to technology and funds that would otherwise not be available

balanced budget - when the gov spends the same amount it collects in taxes

government budget balance = T - G - TR

if there are more inventories than expected, there was more production than spending GDP > AE and theres no need to produce: GDP and employment will decrease

if there were less inventories than expected, there was more spending than production AE > GDP and we need to produce more: GDP and employment will increase

the paradox of thrift

in the long run, increasing saving can increase economic growth bc it provides funds for investment but in the short run, if households save more of their income and spend less of it, they may make themselves worse off by causing AE to fall, thereby pushing the economy into a recession

shifts in the Aggregate Demand curve

increase in interest rate - shifts AD left bc higher interest rates raise the cost to households and firms of borrowing, reducing consumption and investment spending increase in gov purchases - shifts AD right bc gov purchases are a component of AD increase in personal income taxes or business taxes - shifts AD left bc consumption spending falls when personal taxes rise and investment falls when business taxes rise increase in households' expectations of their future incomes - shifts AD right bc consumption spending and the residential investment component of investment increase increase in firms' expectations of future profitability of investment spending - shifts AD right bc investment spending increases increase in the growth rate of domestic GDP relative to the growth rate of foreign GDP - shifts AD left bc imports will increase faster than exports, reducing net exports increase in the exchange rate relative to foreign currencies - shift AD left bc imports will rise and exports will fall, reducing net exports

long run growth is determined by

increases in labor productivity (the amount of goods and services that can be produced by one hour of work) labor productivity= Quantity of output/L (number of hours worked)

stagflation

inflation & recession aka price level increases and GDP decreases aka when a supply shock shifts the SRAS to the left the cause is usually a supply shock as a result of an unexpected increase in the price of a natural resource

the increase in real GDP per capita since like 1900

is smaller than the true increase in living standards

"when the price level falls from 104 to 124, real GDP falls from $5 trillion to $4 trillion. what is a possible explanation for this event?"

less investment, falling exports, decreased consumption

the multiplier effect - the process by which a change in AE leads to a larger change in GDP

multiplier = 1 / 1 - MPC key points: - it occurs both when AE increases and decreases -it makes the economy more sensitive to changes in AE than it would otherwise be -the larger the MPC, the larger the value of the multiplier tax multiplier = MPC/1-MPC if we want to produce more, we need more people working, if we have more people, we need to produce more Y=C+I+G+NX Y and C feed into each other

the total value of saving in an economy

must equal the total value of investment

durable goods are much more impacted by the business cycle than

non durable goods

crowding out

occurs when governments must borrow funds which causes interest rates to rise and thus private investment is reduced

institution

overall incentive structure for economic activity (solid institutions create the atmosphere needed for economic growth)

if the expected price level goes up

people will demand higher wages

economic growth is measured by

percent change in real gdp per capita the only way we see economic growth (a rise in the standard of living) is for the amount of goods and services to grow faster than the population grows

the difference between planned investment and actual investment depends on inventories

planned investment includes what firms plan on putting into inventories actual investment includes what firms actually put into inventories

retained earnings

profits that are reinvested into the firm

what can push the economy away from long run equilibrium?

recession: -if AD shifts to the left, as firms and workers adjust to the price level being lower than expected, costs will fall and shift SRAS to the right -- in the long run, a decline in AD causes a decline only in price level (economists refer to the process of adjustment back to potential GDP as an automatic mechanism bc it occurs without any gov intervention) expansion: -if AD shifts to the right, as firms and workers adjust to the price level being higher than expected, costs will rise and cause SRAS to shift left -- in the long run, an increase in AD causes an increase only in price level supply shock: -if the price of an important good (ex. oil) increases substantially, it will increase many firms' costs and shift SRAS to the left, increasing unemployment and reducing output -eventually, wages and prices fall, and SRAS shifts back to its original position

services the financial system provides

risk sharing - risk is the chance that the value of a financial security liquidity - the ease with which a financial security can be exchanged for money information - facts about borrowers and expectations about returns on financial securities

decreases in the value of the dollar relative to foreign currencies will make the AD curve

shift to the right

short-run aggregate supply curve

shows the relationship between the price level and the quantity of GDP supplied by firms that exists in the short run in the short run, prices can influence the ability to supply bc input prices are much more rigid than output prices -contracts make input prices "sticky" -wages dont adjust at the drop of a hat -menu costs make it difficult to change prices right away

the aggregate demand curve

shows the relationship between the price level and the quantity of real GDP demanded by​ households, firms, and the government. it is downward sloping bc a fall in the price level increases the quantity of real GDP demanded and bc an increase in the price level reduces real money​ holdings, which reduces the amount of expenditures. (the aggregate demand curve is downward sloping because as prices​ rise, consumer real wealth​ declines, interest rates​ rise, and exports become more expensive.)

Why does SRAS slope upward?

slopes up bc in the short run, as price level increases, the quantity of goods and services firms are willing to supply will increase firms supply more goods and services as price level increases bc -as prices rise, firms supply more bc they will profit more -some firms are slow to adjust their prices, so while prices levels rise, their price will become relatively cheaper - causing their sales to increase which will motivate them to increase production basically, some firms and workers fail to accurately predict changes in price level -contracts make some wages and prices sticky -firms are often slow to adjust wages (often slower to cut them than raise them, people tend to be more upset about having their wages cut than having them frozen, so firms often freeze wages during recessions to prevent people from quitting) -menu costs make some prices sticky Profits rise when the prices of the goods and services firms sell rise more rapidly than the prices they pay for inputs.

Economic growth will

slow down or stop if more capital per hour is used because of diminishing returns to capital. Some economies are able to maintain high growth rates despite diminishing returns to capital by using better or enhanced​ technology, along with accumulating​ capital; these economies are growing because​ technology, unlike​ capital, is subject to increasing returns.

in a closed economy net exports are zero

so Y = C + I + G S private = Y + TR - C - T Gov Budget Balance = T - G - TR total saving = S priv + S pub savings = investment

consumption

spending by households on goods and services, with the exception of purchases of new housing

if savers were taxed on their real interest payment rather than nominal interest payments,

supply of loanable funds would increase

expansions tend to last much longer than recessions

the Great Recession was the longest and most severe recession

Great Moderation

the absence of huge fluctuations in real GDP since the 50s possible explanations -the increasing importance of services and decreasing importance of goods -the establishment of unemployment insurance -active federal gov policies to stabilize the economy -the increased stability of the financial system

marginal propensity to save

the amount by which saving changes when disposable income changes (1-MPC)

industrial revolution

the application of mechanical power to the production of goods, beginning in England around 1750 caused long run economic growth with sustained increases in real GDP per capita and raised living standards

short run fluctuations in real GDP per capita are determined by

the difference between total spending and total production in the economy

in the long run, small differences in economic growth rates result in big differences in living standards

the economic growth model focuses on technological change and changes over time in the quantity of capital available to workers

market for loanable funds model

the interaction of borrowers and lenders that determines the market interest rate and the quantity of loanable funds exchanged supply and demand model (supply of funds and demand of funds) between households and firms and banksx

potential GDP

the level of real GDP attained when all firms are producing at capacity historically, potential real GDP has increased over time (bc technology and the labor force has grown)

if aggregate demand shifts right and AE moves up

the price level increases and higher prices demand to workers demanding higher wages, which increases input costs and shifts the SRAS left back to equilibrium also this higher price level causes AE to shift back down

long run economic growth

the process by which rising productivity increases the average standard of living the best measure of the standard of living is real GDP per capita

2 key factors determine labor productivity

the quantity of capital per hour worked and the level of technology

consumption function

the relationship between consumption spending and disposable income C = MPC (Y - T) + C slope is the amount by which consumption spending changes when disposable income changes = MPC (is always between 0 and 1) MPC= change in consumption OVER change in GDP/income the y intercept is autonomous consumption then investment, government spending, and net exports AE = C + I + G + NX the new y intercept is autonomous spending we compare to the 45 degree line: the equilibrium where AE = GDP all points of macroeconomic equilibrium lie on that line

per-worker production function

the relationship between real GDP per hour worked and capital per hour worked, holding the level of technology constant technological change shifts the per worker production function upwards technological change: -better machinery/equipment -increases in human capital -better means of organizing and managing production notice the diminishing marginal returns (real GDP per hour worked increases at a decreasing rate) Equal increases in the quantity of capital per hour worked lead to diminishing increases in output per hour worked.

the aggregate expenditure model focuses on

the short run relationship between real spending and real GDP

the slope of the aggregate expenditure line =

the slope of the consumption function

capital stock

the total amount of physical capital available in a country

Romer focused on knowledge capital bc

the use of physical capital is Rival bc if one firm uses it, other firms cannot, and it is Excludable bc the firm that owns it can prevent other firms from using it knowledge capital is nonrival and nonexcludable so firms can freeride on the research & development of other firms

When examining economic growth rates throughout​ history,

the world experienced little to no growth until the industrial​ revolution, after which some economies began to experience real economic growth.

increases in price level cause aggregate expenditure to fall, causing a larger decrease in GDP decreases in price level cause aggregate expenditure to rise, causing a larger increase in GDP

there are 3 reasons for this relationship -a rising price level decreases consumption by decreasing the real value of household wealth; a falling price level has the reverse effect -if the US price level rises relative to other countries, US exports will become relatively more expensive, causing net exports to fall; a falling US price level has the opposite effect -when prices rise, firms & households need more money to finance buying and selling. the fed will increase the interest rate, and investment spending will fall as firms decrease their borrowing to build new factories or buy new machines and households decrease their borrowing to buy new houses etc; a falling price level has the reverse effect: interest rates will fall and investment spending will rise

in an open economy

there is interaction with other economies through trade and borrowing/lending ....all economies today are open economies

aggregate expenditure

total spending in the economy: the sum of consumption, planned investment, government purchases, and net exports

If menu costs were​ eliminated, the​ short-run aggregate supply curve will be

upward sloping bc of wage price stickiness and slow wage adjustment by firms

when AE is greater than GDP, inventories will decline and GDP and employment will increase

when AE is less than GDP, inventories will increase and GDP and employment will decrease

when SRAD shifts, SRAS shifts to counteract it and creates a new equilibrium

when SRAS shifts, it shifts back to original equilibrium

when determining what level of GDP would result in no unplanned change to inventories

write AE=Y