Macro exam practise
GDP deflator formula
(Nominal GDP/Real GDP) x 100
real exchange rate formula
(e X P)/P* real exchange rate=(Nominal Exchange Rate X Domestic Price) / Foreign Price
A two-sector model
- manufacturing firms produce goods - research universities produce knowledge that increases labour efficiency in manufacturing
Tax Multiplier
-MPC/(1-MPC)*Increase in tax A tax multiplier of -1.5 will mean that a deduction in taxes of 1 unit (for example 1$) will increase income by 1.5 units
Three instruments of monetary policy
-open market operations: By buying and selling bonds -the refinancing rate: the interest rate the central bank charges on loans to banks -reserve requirements: regulations that impose a minimum amount of reserves that banks must hold against depositsx
If demand decreases, but strutucal unemployment also increases
1) According to the analysis in a) the AD-curve shifts leftwards due to the demand shock. 2) The reduction in structural GDP shifts both AS and LRAS leftwards. The demand shock has a negative impact on the price level, while the supply shock has a positive impact on the price level. Without extra assumptions, the model cannot predict which effect dominates. The graph below shows both cases (red: the demand shock dominates, green: the supply shock dominates). The effect on net exports, NX(eP/P*), depends on whether the price level decreases (positive effect on net exports) or increases (negative effect on net exports). Hence, the effect on net-exports is ambiguous.
Government Multiplier
1/(1-MPC)*increase in government spending The amount that income will increase for each extra unit of government expenditure is the government-purchases multiplier, which should be larger than 1 at all times.
MPK The Golden Rule with technological progress
c * is maximized when MPK = &+ n + g
CPI formula
100 x (cost of basket in current year/cost of basket in base year)
A flatter IS curve meaning
A flatter IS curve represents that a change in the interest rate has a greater effect on equilibrium income. In the 45-degree model, a higher (lower) interest rate will cause investment to fall (rise), which lowers (raises) demand and thus equilibrium income - this is the first-round effect. This triggers the multiplier process, where the higher (lower) income raises (lowers) private consumption, which in turn increases (lowers) demand and thus equilibrium income. When the marginal propensity to consume is high, the multiplier process is stronger, so the effect on income is greater, which gives a flatter IS curve.
Laffer Curve
A relationship between the tax rates and tax revenues that illustrates that high tax rates could lead to lower tax revenues if economic activity is severely discouraged.
An increase in the world interest rate/risk prima with floating exchange rate
A rise in the world interest rate affects both the IS* curve and the LM* curve. The IS curve shifts to the left, because investment is depressed. The LM curve shifts to the right, because only a higher income 𝑌 can restore equilibrium in the money market. The result is a lower nominal exchange rate, which will increase net exports, and therefore shift the Keynesian cross outwards again. SVAR fra aspiri En udenlandsk rentestigning vil kræve en tilsvarende indenlandsk rentestigning. Det vil have to effekter: På den ene side vil I falde, hvilket sænke E, og på den anden side vil den udenlandske rentestigning i første omgang føre til nettokapitaludstrømning (CF), der øger udbuddet af indenlandsk valuta og fører til fald i e (en depreciering). Denne depreciering vil øge NX, hvilket vil øge E. I ligevægt må der i praksis ske en stigning i E og dermed i Y , fordi rentestigningen isoleret set sænker M/P , og med givet nominelt pengeudbud, M, må Y stige så meget, at det igen øger M/P , indtil der er ligevægt på PM ved den nye, højere rente. Det svarer til, at stigningen i r både rykker IS* til venstre, og LM* til højre. Som det ses, giver det en ligevægt, hvor e er faldet og Y er steget. Ved sammenligning med opgave 8, spørgsmål 8 ses det altså, at under faste valutakurser virker en udenlandsk rentestigning kontraktivt, mens den virker ekspansivt ved flydende valutakurser
The impossible trinity
A theory that states that a nation cannot have "free capital flows", "independent monetary policy", and "a fixed exchange rate regime" at the same time, but must chose 2 at the expense of the one in the opposite corner.
Taylor Rule
According to this rule, the real official interest rate equals 2 per cent when inflation is 2 per cent and GDP is at its natural level. For each percentage point by which inflation rises above 2 per cent, the real official interest rate rises by 0.5 per cent. For each percentage point by which real GDP falls below its natural level, the real official interest rate falls by 0.5 per cent. If GDP rises above its natural level, so that the GDP gap is negative, the real official interest rate rises accordingly. One way of interpreting the Taylor rule is as a complement to (or a tool of) inflation targeting, which we discuss in the next section.
Ways of modelling expectations
Adaptive expectations: Expectations based on recently observed values Rational expectation: Expectations based on all available information Including information about current and prospective future policies
Imperfect-information model
Also called misperception model: A supplier thinks that relative prices for them are increasing, and that supplier will start producing more working more The imperfect-information model assumes that each supplier in the economy produces a single good and consumes many goods. Because the number of goods is so large, suppliers cannot observe all prices at all times. They monitor closely the prices of what they produce, but less closely the prices of all the goods they consume. Because of imperfect information, they sometimes confuse changes in the overall level of prices with changes in relative prices. This confusion influences decisions about how much to supply, and it leads to a positive relationship between the price level and output in the short run. Unlike the previous two models, this model assumes that markets clear - that is, all wages and prices are free to adjust to balance supply and demand EXAMPLE: Consider how the farmer responds if all prices in the economy, including the price of wheat, increase. One possibility is that she expected this change in prices. When she observes an increase in the price of wheat, her estimate of its relative price is unchanged. She does not work any harder. The other possibility is that the farmer did not expect the price level to increase (or to increase by this much). When she observes the increase in the price ofwheat, she is not sure whether other prices have risen (in which case wheat's relative price is unchanged) or whether only the price of wheat has risen (in which case its relative price is higher). The rational inference is that both have increased to some degree. In other words, the farmer infers from the increase in the nominal price of wheat that its relative price has risen somewhat. She works harder and produces more. Our wheat farmer is not uniqu
Which variables are touched upon in expansionary fiscal policy
An increase in government purchases of goods and services, a decrease in net taxes, or some combination of the two for the purpose of increasing aggregate demand and expanding real output. The effect will not be the same, as it will have a bigger effect on Y when increasing G, because the whole amount is spend on consumption. Where if T is reduced C(Y-T). C will only increase by MPC (some of it will be saved), and E will thereby only increase by the consumption, which is less than one.
money supply formula
C /D is the currency-deposit ratio cr for private households, meaning how much people keep in cash instead of inserting in the bank. REMEMBER to calculate this before inserting it into the formula R /D is the reserve- deposit ratio rr. Describes how much the bank should keep in reserves compared to their deposit.
Difference GDP deflator and CPI
CPI measures a fixed basket of goods and its price over time, and only consumer goods. GDP Deflator measures domestic produced goods and it therefore also takes the new consumption mix into consideration.
Monetary policy under fixed exchange rate
Crowding out can not happen under monetary policy with a fixed exchange rate in mundell flemming, as the r=r* and the central bank has to adjust money supply in the money market
Hysteresis
Hysteresis is the term used to describe the long-lasting influence of his tory on the natural rate. A recession can have permanent effects if it changes the people who become unemployed. For instance, workers might lose valuable job skills when unemployed, lowering their ability to find a job even after the recession ends. Alternatively, a long period of unemployment may change an individuals attitude towards work and reduce his or her desire to find employment.
Loanable funds markets
I=S=Y-C-G. (Y-T)-C= Private savings. (income-taxes)-consumption (T-G)= Public savings. (Transfers-government expenditure)
Two types of inflation
Demand-Pull Inflation: Cause: This type of inflation occurs when the demand for goods and services exceeds their supply. It is often associated with a strong and growing economy where consumers and businesses are spending more money. Factors: Demand-pull inflation can be triggered by factors such as increased consumer spending, business investments, government expenditures, or exports. These factors create a situation where the demand for goods and services outstrips their availability in the market. Effect: As demand outpaces supply, businesses may raise their prices to capitalize on increased consumer willingness to pay. This upward pressure on prices contributes to inflation. Cost-Push Inflation: Cause: Cost-push inflation occurs when the costs of production for goods and services increase, leading producers to raise prices to maintain their profit margins. Factors: Various factors can contribute to cost-push inflation, including rising costs of raw materials, labor, energy, or other production inputs. External shocks such as geopolitical events, natural disasters, or supply chain disruptions can also lead to increased production costs. Effect: When businesses face higher costs, they may pass these costs on to consumers by raising prices. This results in inflation driven by the increased production costs rather than excessive demand. (mention in AD-AS curve)
An increase in the world interest rate/risk prima with fixed exchange rate
En udenlandsk rentestigning vil skulle "adopteres" også af den indenlandske økonomi for at sikre ligevægt på valutamarkedet. Den indenlandske rentestigning vil så sænke I, hvilket sænker E, Y , (Y T) og C. Endelig må CB tilpasse pengemængden, så der rent faktisk er ligevægt på PM ved den nye lavere værdi af Y og den højere rente. Situationen er illustreret i figur 2, hvor IS rykker til venstre, fordi r = r er steget, og LM* "rykker med", s valutakursen holdes uændret. "r* is part of both the IS* and LM* equations and therefore shift the IS* curve to the left due to lower investment. The LM* curve moves immediately to the right due to higher r*, but due to endogenous adjustment in the money supply (fixed exchange rate), the overall effect on the LM* curve is that it moves to the left and ensures a maintained nominal exchange rate. See Ch. 13." svar fra eksamens, læs op på det
imputed value
Estimate of the value of a good or service that is not sold in the marketplace and therefore does not have a market price (black economy)
Loanable funds markets if expansionary fiscal policy (increased G)
Expansionary fiscal policies, through increased government spending or lowering of taxes, will decrease public savings.
The Functions of Money & Types of money
FUNCTIONS OF MONEY As a store of value, money is a way to transfer purchasing power from the present to the future. If I work today and earn €100,1 can hold the money and spend it tomorrow, next week or next month. As a unit of account, money provides the terms in which prices are quoted and debts are recorded. A car dealer tells you that a car costs €20,000, not 400 shirts (even though it may amount to the same thing). As a medium of exchange, money is what we use to buy goods and ser vices.When we walk into a shop, we are confident that the shopkeeper will accept our money in exchange for the items they are selling. TYPES OF MONEY Money that has no intrinsic value is called fiat money because it is established as money by government decree, or fiat. Money of this sort is called commodity money. The most widespread example of commodity money is gold.
GDP definition
GDP is defined as total expenditures on domestically-produced final goods and services. Alternatively, GDP is defined as total income earned by domestically-located factors of production.
Lucas Critique
In his writings on macroeconomic policy making, Lucas has emphasized that economists need to pay more attention to the issue of how people form expectations of the future. Expectations play a crucial role in the economy because they influence all sorts of behaviour. Related to rational expectations. Example: Suppose a government frequently raises taxes whenever unemployment is low. Over time, individuals might anticipate this policy pattern and increase their savings during times of low unemployment to prepare for possible tax hikes. This rational shift in behaviour could alter an economic model's accuracy if it fails to account for this adaptive expectation.
Policy by rule
In macroeconomics, the concept of "policy by rule" refers to an approach where economic policy decisions are guided by pre-established rules or principles rather than discretionary actions by policymakers. This approach aims to provide a more stable and predictable economic environment. For example: Taylor rule
time inconsistency
In some situations, policy makers may want to announce in advance the policy they will follow to influence the expectations of private decision makers. But later, after the private decision makers have acted on the basis of their expectations, these policy makers may be tempted to renege on their announcement. Understanding that policy makers may be inconsistent over time, private decision makers are led to distrust policy announcements. EXAMPLE: Consider the dilemma of a central bank that cares about both inflation and unemployment. According to the Phillips curve, the trade-off between inflation and unemployment depends on expected inflation.The central bank would prefer everyone to expect low inflation so that it will face a favourable trade-off. To reduce expected inflation, the central bank might announce that low inflation is the paramount goal of monetary policy. But an announcement of a policy of low inflation is by itself not credible. Once households and firms have formed their expectations of inflation and set wages and prices accordingly, the central bank has an incentive to renege on its announcement and implement expansionary monetary policy to reduce unemployment. People understand the central bank's incentive to renege and therefore do not believe the announcement in the first place. OR think of the example with the terrorist
Staglfation
Is when inflation is happening because of higher costs, but this also drives down the economy, as that would make firms start producing less, because actual prices exceed the value of expected prices
Rational expectations
It assumes that people have rational expectations. That is, we might assume that people optimally use all the available information, including information about current government policies, to forecast the future.
Will an increase in the saving rate increase consumption? (solow model)
It depends on if it the initial steady state is below or above golden rule. If the initial steady state is below the golden rule level of consumption then it would increase the consumption But if the initial steady state is above the golden rule level steady state, an increase of the saving rate would decrease the consumption.
Solow Golden Rule
It is the point where the distance between production f(k) and investments are highest! The economy does NOT have a tendency to move toward the Golden Rule steady state. Achieving the Golden Rule requires that policymakers adjust s.
Philips curve shifts if the structural unemployment increases?
It shifts the short-run curve upwards, because the structural unemployment is the end of the philips curve REMEMBER: If expected inflation changes, it shifts the Philips curve
In the equation for the Phillips curve, where would an increase in world oil prices be depicted
It would be depicted in v. For example sudden increases in oil prices, will lead to a positive value of this term which will increase inflation. This is referred to as cost-push inflation. v shows the increase in supply costs and create cost-push inflation. u shows the increase in demand-pull inflation
Loanable funds markets increase investment incentive (closed economy)
The investments curve will shift outwards, as people will start to invest more disregarding the interest rate
Endogenous Growth Theory
Models that examine the determinants of the rate of tech progress, which Solow takes as given -Technological growth emerges as a result of investment in both physical and human capital -Increased investment can permanently increase rate of growth -Returns to capital are constant -An increase in savings will permanently increase the growth rate -Capital investment may improve total factor productivity
Monetary base
Monetary base=Currency in circulation+Bank reserves Currency in circulation refers to banknotes and coins held by the public - money we use in our everyday lives. Bank reserves are cash deposits that financial institutions hold in their accounts at the central bank. Not to be confused with the money supply, the monetary base does not include non-cash assets, such as demand deposits, time deposits, or checks. For many central banks, the monetary base is increased through the purchase of government bonds, also known as open market operations. By purchasing bonds from commercial banks, the central bank can replace the illiquid bonds with a cash deposit in the bank's reserve account.
Okun's Law
Okun's law is the link between GDP and unemployment, where if GDP increases by 1% above potential GDP, the unemployment rate drops by 1/2%. Only applies in the short run Mention when commenting on GDP (Y) and employment
Optimum Currency Areas (OCA)
Optimum currency area theory attempts to set down a set of criteria for a group of countries, such that, if the criteria were satisfied, it would in some sense be 'optimal' for the countries to adopt a common currency. High labor mobility: Workers can easily move between member countries. Free capital mobility: Allows efficient resource allocation. Similar business cycles: Shared economic trends and shocks. Price and wage flexibility: Ability to adjust to economic changes. Mechanisms for fiscal transfers: Redistributing resources in times of economic disparities.
AS curve when aggregate demand has shifted outwards
Over time, P e rises, which reduces Y. The fall in Y can be explained within the IS-LM (higher prices raise r, reduce I, and thus Y). With static (or adaptive - see below) expectations, the adjustment takes many periods (gradual shift of AS upwards, due to P>P e Adaptation from the short to the long term is driven by updating expectations (and thus location of the AS curve)
Policy by discretion
Policy by discretion refers to an approach in which policymakers have the flexibility to make discretionary decisions based on their judgment and assessment of current economic conditions.
A basic model (AK model)
Production function: Y = A K where A is the amount of output for each unit of capital (A is exogenous & constant)
Quantitive Easing (asset purchase)
Quantitative easing is a tool that central banks can use to inject money directly into the economy. CB then use it to buy things like government debt in the form of bonds. You may also hear it called 'QE' or 'asset purchase' - these are the same thing. "QE involves us buying bonds to push up their prices and bring down long-term interest rates. In turn, that increases how much people spend overall which puts upward pressure on the prices of goods and services."
Fractional reserve banking and formula
Remember the reserve requirement is what the bank should keep and not lend out. Calculated 1/rr*starting currency Example: reserves ratio=20%, currency=1000 Money supply by inserting 1000 in the bank=1/0,2*1000=5*1000=5000
Seigniorage (Inflation Tax)
Revenue generated by the government's right to print money When the government prints money to finance expenditure, it increases the money supply. The increase in the money supply, in turn, causes inflation. Print ing money to raise revenue is like imposing an inflation tax. At first it may not be obvious that inflation can be viewed as a tax. After all, no one receives a bill for this tax - the government merely prints the money it needs. Who, then, pays the inflation tax? The answer is the holders of money.
Ricardian Equivalence
Ricardian equivalence is an economic theory that says that financing government spending out of current taxes or future taxes (and current deficits) will have equivalent effects on the overall economy. This means that attempts to stimulate an economy by increasing debt-financed government spending will not be effective because investors and consumers understand that the debt will eventually have to be paid for in the form of future taxes. The logic of Ricardian Equivalence is that the private sector realizes that net-present-value of taxes must equal net-present-value of public expenditures.
The costs of expected inflation
Shoeleather costs. Higher inflation means higher nominal interest rates, which mean that people want to hold lower real money balances. If people hold lower money balances, they must make more frequent trips to the bank to withdraw money. This is inconvenient (and it causes shoes to wear out more quickly). Menu costs. Higher inflation induces firms to change their posted prices more often. This may be costly if they must reprint their menus and catalogs. Greater variability in relative prices. If firms change their prices infrequently, then inflation causes greater variability in relative prices. Since free-market economies rely on relative prices to allocate resources efficiently, inflation leads to microeconomic inefficiencies. Altered tax liabilities. Many provisions of the tax code do not take into account the effect of inflation. Hence, inflation can alter individuals' and firms' tax liabilities, often in ways that lawmakers did not intend. The inconvenience of a changing price level. It is inconvenient to live in a world with a changing price level. Money is the yardstick with which we measure economic transactions. Money is a less useful measure when its value is always changing.
When do banks make money on their lending and borrowing activities.
Since deposits exceed reserves, the bank creates liquidity, because the bank don't keep all the money the customers deposit there
What happens with poor and rich countries
Solow model predicts that, other things equal, poor countries (with lower Y/L and K/L) should grow faster than rich ones, which means that they converge. What the Solow model really predicts is conditional convergence—countries converge to their own steady states, which are determined by saving, population growth, and education.
automatic stabilizers
Some fiscal policies, called automatic stabilizers, are designed to reduce the lags associated with stabilization policy. Automatic stabilizers are policies that stimulate or depress the economy when necessary, without any deliberate policy change. For example, the system of income taxes automatically reduces taxes when the economy goes into a recession, without any change in the tax laws, because individuals and corporations pay less tax when their incomes fall. Similarly, the unemployment-insurance and welfare systems automatically raise transfer payments when the economy moves into a recession, because more people apply for benefits. One can view these automatic stabilizers as a type of fiscal policy without any inside lag.
Label the axis for golden rule steady state
Steady state output line and steady-state depreciation
What is the T in C(Y-T)
T makes up taxes-transfer payments, as transfer payments are the income paid by government Remember if government pay higher pension payments this is a part of transfers and not government spending!
True or false? In the Keynesian cross the increase in income from a tax reduction increases in the marginal propensity to consume.
TRUE: The multiplier increases in the marginal propensity to consume. See Ch. 11.
Expansionary fiscal policy adjustment to the long run both shown in AD-AS and IS-LM
The AD-AS will make small shift to the new long run because of the price theory. The IS-LM will shift along the IS-LM because of higher prices shifts the money supply to the left.
If prices increase more in country A than in Country B, which country would export more to which?
The NX from germany to spain has increased, because the products have become relatively cheaper. Real exchange rate=e*p/p*
Primary Budget Balance
The difference between revenues and spending excluding interest payment. The budget balance excluding interest payments.
Budget balance
The difference between tax revenue and government spending
Inside lag
The inside lag is the time between a shock to the economy and the policy action responding to that shock. Monetary policy has a much shorter inside lag than fiscal policy, because a central bank can decide on and implement a policy change in less than a day, but monetary policy has a substantial outside lag.
The Spanish economy was hit extremely hard by the financial crisis in 2007/08. Some economists believe that this shock represented an adverse shock to the Spanish production function and a consequent decline in productivity. a) How would such a shock to the production function affect the Spanish labour demand curve?
The labour demand curve is given by the marginal product of labour schedule faced by firms. If a country experiences a reduction in productivity, then the labour demand curve shifts downward as in Figure 7-1. If labour becomes less productive, then at any given real wage, firms demand less labour.
leverage ratio
The leverage ratio is the ratio of the bank's total assets (the left-hand side of the balance sheet) to bank capital (the one item on the right-hand side ofthe balance sheet that represents the owners' equity). In this example, the leverage ratio is €1000/€50, or 20. This means that for every euro of capital that the bank owners have contributed, the bank has €20 of assets and, thus, €19 of deposits and debts. One implication of leverage is that, in bad times, a bank can lose much of its capital very quickly
Autonomous consumption
The minimum amount of consumer spending when people have no income
Saving rate for the national account identity
The national accounting identity implies S = I + NX. Hence, S / Y = I / Y + NX / Y = saving rate
paradox of thrift
The paradox of thrift is that even though thriftiness increases, saving is unaffected. Increased thriftiness leads only to a fall in income. • Imagine if everyone starts saving more money and spending less because they're worried about the future. Individually, saving money is a good thing—it helps you be financially secure. However, if everyone in an entire economy starts saving a lot and stops spending, businesses don't make as much money because people aren't buying their products. • When businesses make less money, they might start laying off workers and producing fewer goods. This leads to fewer job opportunities and lower incomes for people. As a result, even though individuals are saving more, the overall economy shrinks, and people might end up worse off because there are fewer jobs and less money circulating. • So, the paradox of thrift is the idea that when everyone saves more money individually, it can actually harm the economy as a whole because it reduces overall spending, which is essential for businesses and jobs. So, although people want to save more at a given level of income, their income decreases by an amount such that their saving is unchanged. So, should you not save? Should the government tell people to be less thrifty? No. The results of this simple model are of much relevance in the short run. The desire of consumers to save more is an important factor in many of the recessions. A warning remains, however: policies that encourage saving might be good in the medium run and in the long run, but they can lead to a reduction in demand and in output, and perhaps even a recession, in the short run.
Sacrifice ratio
The percentage of a year's real GDP that must be forgone to reduce inflation by 1 percentage point. We can use the sacrifice ratio to estimate by how much and for how long unemployment must rise to reduce inflation. If reducing inflation by 1 percent age point requires a sacrifice of 2 per cent of a year's GDP, reducing inflation by 4 percentage points requires a sacrifice of 8 per cent of a year's GDP.
Mundell-fleming (floating exchange rate & fiscal policy)
The picture shows fiscal policy which shifts the IS curv outwards. Y will not end up changing, because the positive from government spending, will be lowered by the increased exchange rate which decreases NX.
money supply
The quantity of money available in the economy. Money supply=currency+demand deposits Currency is what people have in cash Demand deposits is what people have in the bank and investments which people can access quickly. The money supply of a country, on the other hand, refers to the total amount of money in circulation. This includes banknotes, coins, and money held by consumers at bank accounts.
currency-deposit ratio
The ratio of the amount of currency that people choose to hold to the amount of demand deposits they hold at banks. The higher the lower the money multiplier. C /D is the currency-deposit ratio cr
What happens to the LM curve if prices drop from the AD curve
The real money market balances shifts the curve outwards
Adverse selection
The situation in which one party to a transaction takes advantage of knowing more than the other party to the transaction Example: investors who know their projects are less likely to succeed are more eager to finance the projects with other people's funds. The financial system helps mitigate the effects of asymmetric information.
Sticky price theory
The sticky price theory is an economic concept that suggests prices do not adjust immediately to changes in supply and demand. Instead, prices tend to be "sticky" or slow to change. According to this theory, various factors, such as menu costs (the costs associated with changing prices) or psychological barriers, can make businesses reluctant to adjust their prices frequently. In the context of macroeconomics, sticky prices play a role in explaining short-term fluctuations in economic output and employment. For example, during an economic downturn, firms may be hesitant to reduce wages or lower prices, leading to a situation where supply and demand imbalances persist for a period before adjustments occur.
Is the sticky-price model pro-cyclical or counter-cyclical?
The sticky-price model implies a pro-cyclical real wage: Suppose aggregate output/income falls. Then, • Firms see a fall in demand for their products. • Firms with sticky prices reduce production, and hence reduce their demand for labor. • The leftward shift in labor demand causes the real wage to fall.
Sticky (real) wage countercyclical?
The sticky-wage model implies that the real wage should be counter-cyclical to the business cycle An unexpectedly high price level decreases the real wage, which causes firms to hire more workers and produce a higher quantity of goods and services (AS curv) In booms, when prices typically increase, the real wage falls In recession, when prices typically falls, the real wage rises The reason for this is wage rigidity
Classic Dichotomy
The theoretical separation of nominal and real variables
Outside lag
The time from the political action until it starts influencing the economy. The outside lag is the time between a policy action and its influence on the economy. This lag arises because policies do not immediately influence spending, income and employment.
Small open economy with floating exchange rate and a expansionary fiscal
The total income will be unchanged because the reduced net exports due to higher exchange rate will decrease as much as the for example government spending increased. AD-AS curv: Hence, in terms of the AD-AS model, there is no shift in the AD curve, and no change whatsoever in the equilibrium depicted under
capital is destroyed in the Solow model/population increase permanently
Then there will be less capital per worker, and investments will be higher than depreciation until it reaches the initial steady state again. The growth will be higher until it reaches the steady state again.
Adaptive expectations
This assumption is called adaptive expectations. For example, suppose that people expect prices to rise this year at the same rate as they did last year. The Philips curv depend on adaptive expectations
What happens if prices drop, which curves are affected?
This shifts the AS curv downwards as a shock The real money market balances moves outwards
Government buying bonds
This will increase money supply, as they give cash to the banks for their bonds Buying and selling government bonds are an important way to make monetary policy
The steeper the IS curve, the lower the crowding out of private investments if the government conducts expansionary fiscal policy in a closed economy.
True. The slope of the IS curve depends on how strong investments react to a change in r. An increase in G (or a reduction in T) increases Y for a given r and thus shifts the IS curve to the right. The increase in Y increases the demand for liquid assets and thereby leads to an increase in r via adjustments in the money market. This increase in r than reduces investments. If the IS curve is steep, a change in r has a relatively small impact on I and thus Y. Thus, the crowding out of private investments is relatively low. One can provide graphical analysis in the IS-LM model.
Exogenous variables
Variables that a model takes as given A model can't predict the value of the variable if it's exogenous, though, as exogenous variables exist outside of the model. Example: A company made a net income of $200,000 last year. Its net income depends on a variety of factors, including tax rate. Because other variables can 't impact the tax rate in the model, the tax rate is an exogenous variable.
Endogenous variables
Variables that a model tries to explain (which are affected by other variables in the model) If the variable depends on variables within the model, though, it's endogenous. Another tip for classifying a variable is to consider whether the economic model you're using can predict the value of the variable. If the variable is endogenous, the model can predict its value, as endogenous variables exist within the model.
real wage and real rental rate
W/P denotes the real wage rate, which means the wages paid to the employees relative to the price level R/P denotes the real rental rate, means the rent paid of accuring the machines compared to the price level Managers will keep hiring as long as long as PxMPL exceeds the wage.
Simple Solow Model
Will always move towards steady state, and the investment and consumption will be fixed. For the whole economy will the growth rate be n+g (population growth+technological progress), as the capital and consumption will be fixed
National Income Identity for an open economy
Y = C + I + G + NX
equation for the loanable funds market in a open market
Y-C-G=I+NX
liquidity trap
a situation in which conventional monetary policy is ineffective because nominal interest rates are up against the zero bound Might have to pursue fiscal policy too in order to reach the goal
Quantity of Money Theory
a theory about the connection between money and prices that assumes the velocity of money is constant. This can be seen from the quantity equation: 𝑀 ∗ 𝑉 = 𝑌 ∗ 𝑃, which can be written in changes as 𝑀̂ + 𝑉̂ = 𝑌̂ + 𝑃̂, where the hats indicate percentage changes. If 𝑉 is constant, then 𝑃̂ = 𝑀̂ − 𝑌̂, and 𝑃̂ equals zero whenever 𝑀̂ = 𝑌̂
What are the stages in the business cycle
expansion, peak, recession, trough
Fisher Equation
nominal interest rate=real interest rate+expected inflation This means that an increase in inflation (π) causes and equal increase in (i)
crowding out
occurs when expansionary policy drives up the interest rate and leads to reduced investment spending
What is sgold in the Solow model
sgold is the specific saving rate, which creates the steady state for kgold
natural rate hypothesis
the claim that unemployment eventually returns to its normal, or natural, rate, regardless of the rate of inflation in the long run
wage rigidity
the failure of wages to adjust Minimum Wage Laws: Government-imposed minimum wage laws set a floor on wages, preventing them from falling below a certain level. While these laws aim to protect workers, they can contribute to wage rigidity by making it difficult for wages to adjust downward in response to economic downturns. Collective Bargaining: Labor unions negotiate collective bargaining agreements with employers to set wages and working conditions. These agreements often have fixed terms, and during the contract period, wages may not be easily adjusted, even if economic conditions change. Efficiency Wages: Some employers pay wages that are higher than the market equilibrium to motivate and retain high-quality workers. This practice can lead to wage rigidity, as employers may be hesitant to lower wages during economic downturns.
Labour force
the total number of workers, including both the employed and the unemployed Labour force participation=labour force/adult populationx100
Spending solow model
y=i+c, all income is used for either investments or consumption (assumed no government and closed economy)
