macro exam 2
contraction
a period of economic decline marked by falling real GDP
budget deficit
a situation in which the government spends more than it takes in
budget surplus
a situation in which the government takes in more than it spends
positive output gap
actual > potential (strong AE)
The IS curve is constructed by:
adding up the level of aggregate expenditure at each real interest rate.
Credit constraints limit the
amount of money that people can borrow.
Hyperinflation
an extremely high rate of inflation.
mutual fund
an investment program funded by shareholders that trades in diversified holdings and is professionally managed.
medium of exchange
an item that buyers give to sellers when they want to purchase goods and services - money for a good
level of savings
real income - real consumption
What drives investment?
real interest rate
money illusion is the
tendency to focus on nominal values instead of inflation-adjusted values.
liquidity
the ability to quickly and easily convert investments into cash with little or no loss in value
compounding
the accumulation of money over time as interest is earned
If actual GDP is greater than potential GDP:
the economy can experience inflation.
risk premium
the extra interest that lenders charge to an account for the risk of loaning money
output gap
the gap between real GDP and potential GDP
peak
the highest point in the business cycle
MPC (marginal propensity to consume)
the increase in consumer spending when disposable income rises
risk-free interest rate
the interest rate at which money can be borrowed or lent without risk over a given period
Great Moderation
decreased volatility of the US economy
expansion
A period of economic growth as measured by a rise in real GDP
Recession
A slowdown in a nation's economy
efficent market hypothesis
A theory that describes what type of information are reflected in current stock prices
output gap formula
((actual output - potential output)/potential output) X 100
rate of inflation formula
(Current CPI - Old CPI) / Old CPI
MP (monetary policy) curve
- shows the current real interest rate - controlled by the Fed
GDP multiplier formula
1/(1-MPC)
inflation
A general increase in prices
Depression
A long-term economic state characterized by unemployment and low prices and low levels of trade and investment
spending shocks
Any change in aggregate expenditure at a given real interest rate and level of income. Spending shocks shift the IS curve.
financial shocks
Any change in borrowing conditions that changes the real interest rate at which people can borrow. Financial shocks shift the MP curve.
CPI formula
Current basket/base basket X100
Business investment =
Equipment + Business structures + Intellectual property
Present Value Formula
FV/(1+ir)^n
Okun's rule of thumb
For every 1 percentage point that actual output falls below potential output, the unemployment rate rises by 0.5
Leading vs Lagging Indicators
Leading indicator → variable to predict the future path of the economy Lagging indicator→ variables that tend to follow the business cycle movements
Real GDP formula
Nominal GDP/GDP Deflator x 100
GDP deflator equation
Nominal GDP/Real GDP x 100
rational rule for investors
Pursue an investment opportunity if the present value of future revenues exceeds the up-front cost
The three major pillars of the financial sector are the:
banks, bond market, stock market
MPC formula
change in consumption/change in income
The slope of the consumption function is equal to
change in consumption/change in income (same thing as MPC)
stock prices can predict
changes in GDP
what causes shifts to the MP curve
changes in monetary policy financial shocks
how do you find the current cost with old and current CPI given
current CPI/old CPI x cost
depreciation
decline in capital due to wear and tear, damage, and aging
A decrease in investment demand
demand shifts left interest rates decrease
Increase in investment demand
demand shifts right interest rates increase
Four stages of the business cycle
expansion, peak, recession, trough
Government expenditure
government consumption
budget deficit
government spends more than it takes in
budget surplus
government takes in more than it spends
consumption smoothing
having a balance between saving and consuming to optimize a persons living standard
how do interest rates affect investment
higher interest rates = investment falls
Market Capitalization
how much a company is worth
what is the relationship between capital stock and depreciation
if depreciation is greater than capital investment capital stock goes down (vice versa)
S&P 500
index that shows the price changes of different stocks
What drives investment?
interest rates
trough
lowest point of a recession
the intersection of the IS and MP curve determine
macroeconomic equilibrium
rational rule of consumption
marginal benefit of consumption of a dollar today is greater than the marginal benefit of spending a dollar plus interest in the future.
menu costs
marginal costs to firms of changing prices
Functions of Money
medium of exchange, unit of account, store of value
Net Financial Outflow
money leaving a buisness
planned investment
money spent on capital stock that is planned by firms
real interest rate vs nominal interest rate
nominal - does not take in inflation real - inflation adjusted
real rate of return formula
nominal rate - inflation rate
If the consumer price is lower than last year
on average in the economy prices went down
consumption is based on
permanent income
negative output gap
potential > actual (weak AE)
Future Value Formula
present value (1+IR)^n
the fundamental value of a business
present value of the future profit it will earn
user cost of capital formula
price x (depreciation + real interest rate)
difference between saving and investment
saving: money left over from spending investment: purchase of new capital
loanable funds market
shows the demand for funds generated by borrowers and the supply of funds provided by lenders
IS (investment savings) curve
shows the relationship between real interest rate and ouput gap
what causes shifts to the IS curve
spending shocks occur
GDP deflator tracks
the price of all goods and services produced domestically
default risk
the risk of not getting paid
Liquidity Risk
the risk that your bond will not resell of you need the funds quickly
capital stock
the total quantity of capital at a point in time
inflation rate between last year and this year
total basket goods this year - total basket goods last year / cost of basket goods last year
multiplier formula
total gdp / government spending
Aggregate Expenditure
total spending on final goods and services in an economy AE = C+I+G+NX
term risk
uncertainty about future interest rates since your money will be tied up in a bond
what is the output gap when potential = actual
zero
