Midterm 2 Study

Cyclical Unemployment

Neither frictional nor structural ○ People are unemployed because the economy is below productive capacity due to business cycles.

Steady state

a state in which inputs equal outputs, so that the system is not changing over time

Rate of return

an asset's increase in value per unit of time

When a person purchases a 90-day Treasury bill, he or she cannot know the:

ex post real interest rate.

P =

is the price of a typical transaction (# of dollars exchanged)

Frictional unemployment

time and effort it takes to search for a job. ■ Even with flexible wages and enough jobs. ■ Occurs.. ● Differences in geographic locations ● Lack of information

The quantity theory of money assumes that:

velocity is constant

output per worker formula

y=Y/L

Md = P × L(i, Y)

▪ Md is nominal money demand (aggregate) ▪ P is the price level ▪ L is the money demand function ▪ Y is real income or output ▪ i is the nominal interest rate on nonmonetary assets ▪ Other determinants are omitted to focus on i, Y, and P

%ΔM + %ΔV = %ΔP + %ΔY

%ΔM is controlled by Fed ● %ΔV is - b/c Velocity is constant ● %ΔP is inflation ● %ΔY is dependent on growth in factors of production and technological progress

The portfolio allocation decision Main factors:

- Expected return - Risk - Liquidity - Time to maturity

steady state of unemployment

# who leave jobs = # who find jobs

Depreciation

A constant fraction d of the capital stock wears out every year

If the money supply is held constant, then an increase in the nominal interest rate will ______ the demand for money and ______ the price level.

decrease; increase

Real wage decrease=

effort decrease = productivity decreases = Demand Curve left shift = higher unemployment rate temporarily

Equilibrium in the market for goods and services determines the ______ interest rate, and the expected rate of inflation determines the ______ interest rate.

ex ante real; ex ante nominal

i=r+π π e =

expected inflation rate

Higher investment

higher labor demand = Demand Curve right shift = lower unemployment than natural rate temporarily

A rate of inflation that exceeds 50 percent per month is typically referred to as a

hyperinflation

ex ante real interest rate

i - π e/ the real interest rate people expect at the time they buy a bond or take out a loan

ex post real interest rate

i - π/ the real interest rate actually realized

nominal interest rate equation

i = r+π Real interest rate plus inflation

The Fisher Effect

i=r+π <- "Fisher Equation" i = nominal interest rate r= real interest rate π= inflation rate

According to the classical theory of money, inflation does not make workers poorer because wages increase:

in proportion to the increase in the overall price level.

T = (Transactions)

is the number of times in a year that goods or services are exchanged for money.

M =

is the quantity of money in the economy

capital per worker formula

k=K/L

With more capital stock

labor productivity would increase. The MPL/labor demand curve shifts up. The equilibrium real wage will increase.

The real return on holding money is

minus the inflation rate

The characteristic of the classical model that the money supply does not affect real variables is called:

monetary neutrality

The opportunity cost of holding money is the

nominal interest rate

P*T =

number of dollars exchange in a year

The Nominal IR

opportunity cost of holding money

real interest rate formula

r = i-π The nominal interest rate minus inflation.

The inconvenience associated with reducing money holdings to avoid the inflation tax is called:

shoeleather costs.

Given that M / P = kY, when the demand for money parameter, k, is large, the velocity of money is ______, and money is changing hands ______.

small; infrequently

The costs of unexpected inflation, but not of expected inflation, are:

the arbitrary redistribution of wealth between debtors and creditors.

Liquidity

the ease and quickness with which an asset can be traded (and turned into purchasing power)

In the long run, according to the quantity theory of money and classical macroeconomic theory, if velocity is constant, then ______ determines real GDP and ______ determines nominal GDP.

the productive capability of the economy; the money supply

Boom

Actual unemployment falls below natural rate (unemployment < natural)

Recession

Actual unemployment rises above natural rate (unemployment > natural)

Quantity Theory of Money

Assumes velocity is constant ○ M*V=P*Y : M*constant V = Nom GDP

Sectoral Shifts

Changes in composition of demand in industries or regions ● Workers skill and abilities no longer desired for certain jobs ■ Ex. Tech change ■ Cause Frictional unemployment

Seigniorage

Gov't prints money as a source of revenue. Causes inflation and therefore acts like a tax on citizens

Change in Capital Stock =

Investment + Depreciation

Model of Natural Rate

L = # of workers in the labor force. ← exogenously fixed U = # of unemployed U/L = unemployment rate E = # of employed workers = L - U s = rate of job loss <- exogenous f = rate of job find <- exogenous

quantity equation of money

M x V = P x T : Money*Velocity = Price*Transactions

Corporate stock

Rate of return = dividend yield + percent increase in stock price

Bank account

Rate of return = interest rate

Wage rigidity

Structural unemployment: # of jobs available < # of people willing to work. RW > equilibrium. ○ Causes disequilibrium in the job market Caused by: ■ Standard Minimum wage laws (min wage > equilibrium wage) ■ Labor unions (union wage > equilibrium wage) ● Benefits union members ■ Efficiency Wages (higher wage = higher efficiency, company raise wage > equilibrium wage). ● Firms purposely pay higher wages, more productivity, but in turn creates gaps in the job market

The Production Function

The production function shows how the amount of capital per worker k determines the amount of output per worker y=f(k)

V = (Velocity of Money)

The rate at which money is circulated in the economy, V = (P*T)/M : Velocity = (Price*Transactions)/Money

If the real interest rate increases by 1, consumption will decrease by 50.

This is because higher interest rates increase the cost of borrowing, which makes it costlier for consumers to use borrowed money to consume. It also encourages saving, which reduces current consumption

Natural rate of unemployment

Unemployment that happens when the economy's production is at the long-run level / Average rate of unemployment.

Full Employment

○ Not when unemployment = 0 ○ When Frictional or Structural, aka. No Cyclical unemployment