Econ 102 Midterm 2

Based on the​ Laffer's theory why do lower tax rates increase government​ revenue?

When workers get to keep more of their​ salary, they will work harder thus increasing the tax base.

COMPONENTS OF AD OVER THE BUSINESS CYCLE

Y = f(A,K,L) = C + I + G + NX

If the government distributes a rebate ​(as part of a temporary tax cut​) to tax​ payers,

a college student who receives the tax rebate is likely to use the rebate to increase current​ consumption, since she bases her consumption on current​ income, but a middle aged married man is likely to save the​ rebate, since he bases his consumption on permanent or​ long-term average income.

John Maynard Keynes believed that the Great Depression was best explained by

a coordination failurein both labor and product markets

Assets with higher likelihood of less-than-full repayment (known as default) must offer

a higher rate of return to compensate for risk

Who developed the theory of scale of the market?

adam smith

marginal propensity to consume (MPC) equation

additional consumption/additional income

marginal propensity to save (MPS) equation

additional savings/additional income

The 1981 tax cuts that occured during the beginning of the first term of President Ronald Reagan emphasized the effects of

aggregate supply and not increases in aggregate demand.

The multiplier effect occurs because

an initial change in output will affect the income of households and thus change consumer spending.

In equilibrium, there are no

arbitrage opportunities in financial markets

Retained Earnings

are what's left after paying out dividends. These are monies held for internal investments, to add to emergency ("rainy day") funds, or for upcoming debt payments.

Q theory----> investment:

as stock prices fall InvestmentSpending falls (holding interest rates constant). This is a shift in Id

The value of the CDS is derived from the value of an

asset (bond).

Taxes and transfer payments that stabilize GDP without requiring explicit actions by policymakers are called

automate stablizers

The aggregate demand curve will shift from any of these four​ sources:

consumption​ spending, investment​ spending, government​ purchases, and net exports.

Fluctuations in the economy can be seen as failures in

coordination

A policy of not enforcing patents or copy rights would ▼ increase decrease the incentive to be innovative.

decrease

Arbitrage equalizes

expected real rates of return

​Schumpeter's view of creative destruction is a process in which

firms will try to break a monopoly​ firm's dominance through more innovation.

Openness is related to

greater competition, which encourages innovation that leads to growth •there are also data showing openness is positively correlated with innovation/technological progress

the elderly population is

growing rapidly and living longer

The method that Solow developed to measure technological progress is called

growth accounting

Suppose the typical business cycle becomes shorter. This makes the conduct of active fiscal policy

harder because lags in policy can now do potentially more harm.

Current U.S. income taxes are not ____ by either ______ or ________ standards

high historical international

The wages of which of the following groups will not adjust​ quickly?

high school teachers

Using​ Tobin's Q-theory of​ investment,

high stock prices lead to high investment levels.

Here an increase in AD leads to _______ ______, _______ _____, and therefore an .....More labor means more output, so GDP rises (Look at gray

higher prices, lower real wages increase in demand for labor

Initially, an increase in desired spending will shift the aggregate demand curve .....

horizontally to the right from a to b. LOOK AT GRAPH CHAPTER 9

Note that your Social Security income depends on

how much you pay into the system and that there are incentives to delay retirement. Both create incentives to work.

Suppose the supply of money​ increases, causing output to exceed full employment. As a​ result,

in the short​ run, both prices and real output will increase and in the long​ run, prices will increase​ further, but real output will fall to the full employment level.

inequality provides....

incentives to stay in school

*These "taxable income" numbers are

income above a tax-free threshold established by either standard per-person deductions or by itemized deductions

What is the largest component of federal revenue?

income taxes

A worldwide patent and copyright systemA worldwide patent and copyright system would ▼ increase decrease the incentive to be innovative.

increase

The time taken by policy makers to recognize an economic problem and take appropriate actions is known as

inside lags

A CDS(Credit Default Swap) is an

insurance contract on a risky bond

Net interest will increase when ▼ depreciation interest rates rise and when the stock of ▼ capital debt held by the public increases.

interest debt

The cost to hedge could widen further if

investors come to expect the Fed could tighten policy more than expected or if the ECB scales back its forecasts.

Computers have revolutionized banking for consumers through the growth of ATMs and electronic bill paying capabilities. All of these improvements for consumers might not be counted as technological progress because technological progress

is defined by economists as an increase in output with no additional increases in inputs.

One key factor keeping away foreign Treasury buyers is the

is the high cost of reducing the currency risk of holding U.S. assets, a move known as hedging.

Arbitrage

is the process of making profits

Though a stronger dollar is desirable for U.S. consumers because it enhances their purchasing power,

it also raises investor fears about debt sustainability for emerging market countries that have borrowed heavily in the currency, such as Turkey, analysts said.

C-though it is procyclical,

it doesn't move very much. We say that consumption is smooth.

Income inequality can get so bad that the poor

just give up, or lose political and economic power, and this can be bad because resources are wasted.

It is very difficult to implement stabilization policies because of

lags and the inability to accurately forecast aspects of the economy.

Tax rates within income groups can fluctuate because of either

legislative changes in marginal income tax rates, changes in the income cutoffs for the tax brackets, and/or because of changes in personal income that move earners into different tax brackets.

In​ 2014, China decided to cut back on its economic growth in order to prevent imbalances from occurring in their economy. With slower economic growth in​ China, there is

less opportunity for exports to​ China, so aggregate demand in the rest of the world will decline.

Suppose that computer hackers managed to crash the Internet in the United States for a week and no one had computer access. This might be considered a negative supply shock because

less output will be able to be produced at any price.

In early 2015 after the decline in oil​ prices, major U.S. oil companies announced that they planned to cut back their investment spending for at least several years. With lower oil​ prices, investments are

less​ profitable, and it would shift the aggregate demand curve to the left.

The ▼ long short ​-run aggregate supply curve is a ▼ vertical horizontal aggregate supply curve that reflects the idea that in the ▼ long short ​run, output is determined solely by the factors of production and technology.

long vertical long

Assets that are more liquid can offer

lower rates of return as liquidity has value to savers

Which program takes up the largest portion of the federal budget​ currently?

medicare/medicaid

Traditional Keynesians think that fiscal policy has a

more than one-for-one effect on the economy.

The "quick fix"

of extending the retirement age so that people collect fewer years of Social Security and Medicare isn't as straightforward as it seems, as it turns out not everyone is living longer (just the wealthy)

By definition, the Current Account (dominated by the Trade Balance or NX) moves

one for one with changes in total borrowing by the private and government sectors. In most years the private domestic balance (household savings = I) moves in the opposite direction of government borrowing, suggesting either or both crowding out of I or rational behavior on the part of households who save more in anticipation that the fiscal stimulus is temporary (reduced fiscal multiplier). In periods in which government borrowing dominates the data, we of course see a fall in the current account.

The time it takes for policy actions to have their effect on the economy is known as

outside lags

Suppose one country has a GDP that is​ one-eighth the GDP of its richer neighbor. But the poorer country grows at 10 percent per​ year, while the richer country grows at 2 percent per year. In 35 ​years, the ▼ poorer richer country will have a higher GDP. (Hint: Use the rule of​ 70.)

poorer--> The richer​ country's GDP will double every 35 years but the poorer​ country's GDP will double every 7 years. Even if the poorer​ country's GDP is initially​ one-eighth the size of the richer​ country's, in 35 ​years, the poorer​ country's GDP will be twice the size of the richer​ country's GDP.

The accelerator theory says current investment spending depends

positively on expected growth of real GDP.

Social Security and Medical spending increases are not the result of policy changes but rather are the result of

predictable aging of the population and the result of rising health-care costs for the elderly. This is an issue facing all of North America, Australia, New Zealand, Europe, and Japan.

To get future returns in terms of what they are worth today, we use a

present value formula

The U.S. economy witnessed federal budget surpluses in the late 20th century under

president Clinton

The​ short-run aggregate supply curve shows the​ short-run relationship between the

price level and the willingness of firms to supply output to the economy.

U.S. income tax system is

progressive

Which of the following methods has the World Bank not tried to assist developing​ countries? A. Promotion of universal education. B. Infusions of new machinery. C. Increases in foreign aid. D. Promotion of population growth.

promotion of growth

The graph at right shows total output as a function of the stock of capital and two lines of depreciation as a function of the stock of capital. The initial depreciation line is dK​, and the new depreciation line is ​dK'. In this​ case, the society switches to equipment that depreciates _______ . In this​ case, the stock of capital will _________ and output Y will _________ .

rapidly decrease decrease

To gauge living standards across countries with populations of different​ sizes, economists use

real GDP per capita

In the​ U.S., virtually all states have requirements that they either plan for or maintain a balanced budget. If the national economy experiences a​ recession, states should ▼ reduce increase their spending and perhaps also ▼ increase lower their taxes to balance their budgets.

reduce increase

Over 2000-2012 the combination of "temporary" tax cuts and poor economic conditions combined to

reduce collections.Poor economic conditions influenced both spending and receipts.

life expectancy rich v poor

rich men live longer than their parents while the poor life expectancy has not changed.

Decreases in taxes, increase in government spending, and an increase in the supply of money all shift the aggregate demand curve to the

right

expansionary fiscal policy shifts the aggregate demand curve to the ____, ______ ​prices, and _____ real GDP.

right rises increases

an expansionary fiscal policy shifts the aggregate demand curve to the ____, ____ prices, and ________ real gdp

right raises increases

As stock prices​ rise, investment spending

rises along with stock prices

Adam Smith stressed that the

size of a market was important for economic development.

Investment is a ▼ larger smaller portion of GDP than​ consumption, but is substantially ▼ more less volatile.

smaller more

federal deficits--> The government is _____ more than its ______

spending earning

in late 1990's, tax increases, limited government spending, and economic growth which increased revenues resulted in

the U.S. experienced a surplus

Output and prices are determined at .....

the intersection of AD and AS.

Firms form expectations about

the marginal productivity of investments.

Direct Lending--> Under perfect competition

the net return equals the deposit rate (if such lending takes place at all, that is!)

the price of a stock can be written as

the present value of all expected future dividend payments

In the long​ run, if aggregate demand decreases​,

the price level will decrease and output or real GDP will remain unchanged.

Capital deepening comes to an end because of the

the principle of diminishing returns

The aggregate demand curve slopes downward, indicating that

the quantity of aggregate demand increases as the price level in the economy falls.

A change in the return in one type of asset will affect

the returns in other types of assets as people shift their savings around to get the highest real return

Arbitrage implies all equilibrium expected real rates of return are

the same, "interest rate" = return on investments

the reseal market price is known as

the secondary market

Openness increases

the size of the market for firms with economies of scale or market power

In a​ supermarket, prices for tomatoes change​ quickly, but prices for mops tend to not change as rapidly because

the supply of tomatoes fluctuates frequently whereas the supply of mops does not.

outside lags

the time it takes for the policy to actually work

New growth theory suggests that investment in comprehensive education in a developing country will lead to permanent increases in the rate of technological progress.

true

In a recession, real GDP falls short of potential GDP. This implies that

unemployment has risen​, driving wages down. This results in a rightward shift of the​ short-run aggregate supply curve.

In a recession​, real GDP falls short of potential GDP. This implies that

unemployment has risen​, driving wages downdown. This results in a rightward shift of the​ short-run aggregate supply curve.

The​ long-run aggregate supply curve is

vertical

Investment is the most ________ component of AD; hence the term

volatile "business cycle."

For most firms, the biggest cost of doing business is _______. If wages are sticky, firms' overall costs will be sticky as well. This means .....

wages that firms' product prices will remain sticky (slow to adjust to equilibrium) too.

Convergence seemed to do a good Job describing the data until The 1980's, but lately

we have Only seen it for a few countries

As the purchasing power of money changes, the aggregate demand curve is affected in three different ways:

wealth effect, interest rate effect, international trade effect

The aggregate demand curve is downward sloping because of the

wealth​ effect, the interest rate​ effect, and the international trade effect.

wealth effect

when the price level falls, the real value of money increases and so spending increases.

Real expected return from lending =

{the nominal rate of return} - {the expected inflation rate} - expected risk - transaction costs and taxes

What do you think is the greatest economic policy concern for the current US economy? Why?

½ point for a concern, ½ point for a reason

If the ​$175 is received in two years ​(at the same interest rate​), the present value will equal

​$147.29

What is the connection between property rights and economic growth?

• Without clear property rights, there are no proper incentives to invest in the future—the essence of economic growth.

How have recent financial innovations created new risks for the economy?

•As securitization developed, it allowed financial intermediaries to provide new funds for borrowers to enter the housing market. •As the housing boom began in 2002, lenders and home purchasers began to take increasing risks. Lenders made "subprime" loans to borrowers with limited ability to actually repay their mortgages. •Some households were willing to take on considerable debt because they were confident they could make money in a rising housing market. Lenders securitized the subprime loans and financial firms offered exotic investment securities to investors based on these loans. Many financial institutions purchased these securities without really knowing what was inside them. •When the housing boom stopped and borrowers stopped making payments on subprime loans, it created panic in the financial market. Effectively, through securitization the damage from the subprime loans spread to the entire financial market, causing a major crisis.

The Fiscal Multiplier in the Keynesian Model

•As the government develops policies to stabilize the economy, it needs to take the multiplier into account. •According to the traditional Keynesian multiplier effect, the total shift in aggregate demand will be larger than the initial change in spending or taxes. •In extreme casesExpectationsabout future tax effects of policy may dampen the fiscal multiplier

result of poor country bad policies

•Fewer exports •Uncertain financial environment • Reduced saving and investment

Education can contribute to economic growth in two ways.

▪First, the increased knowledge and skills of people complement our current investments in physical capital. ▪Second, education can enable the workforce in an economy to use its skills to develop new ideas or to copy ideas or import them from abroad.

Stabilization Policy—based on Keynesian model

"Counter" the business cycle by increasing G spending or cutting taxes during downturns Strengthen the "safety net" because the labor market is "broken" and workers can't get work by taking pay cuts

Conventional wisdom suggests

"as the Fed lifts rates it will pull money into the dollar—we're the high yielder," said Kathleen Gaffney, a bond manager at Eaton Vance. "Hedging costs are interfering with that now."

Federal spending surged during the Great Recession as a result of

"automatic stabilizers," extensions of income-support programs, and discretionary increases in Government spending (G) known as "the federal stimulus"

If the multiplier for taxes is −1.20 and taxes aretaxes are increased by ​$110 ​billion, calculate the amount by which the demand curve will ultimately shift. Shift of the demand curve​ = ​

$132 billion.

If the interest rate is 9 ​percent, the present value of ​$175 paid one year from now equals ​

$160.55

If the interest rate is 9 ​percent, the present value of ​$300 paid one year from now equals ​

$275.23

Dividends

(shares of profits paid out periodically) The future resale price of the stock

Outside the top 0.5% of wage-earners...

, returns to labor seem well-predicted by schooling, major field of study, and experience (i.e. by economic theory that w/p = mpl)

If the multiplier for taxestaxes is negative 1.40 and taxes are increased by ​$130 ​billion, calculate the amount by which the demand curve will ultimately shift. Shift of the demand curve​ = ​$____ billion. ​(Enter your response as an integer and include a minus sign if​ necessary.)

-182 (amount by which the curve shifts)

If annual per capita GDP growth is 2.5%,

-It takes 28 years to double standards of living -After 10 years standards of living are already about 25% higher

If annual per capita GDP growth is 2%,

-It takes 35 years to double standards of living -After 10 years standards of living are already about 20% higher

How will our society cope with increased demands for these services?Possible solutions: (4)

-Leave the existing programs in place and just raise taxes to pay for them. •The government should save and invest now to increase GDP in the future to reduce the burden on future generations. •Reform the entitlement systems, placing more responsibility on individuals and families for their retirement and well-being. •Reform the health-care system to encourage more competition to reduce health-care expenditures.

A bond is a written contract that specifies

-The coupon The date of full repayment (the term) The repayment price The resale market price

In one​ year, a​ consumer's income increases by ​$300 and her savingssavings increases by ​$140. Her marginal propensity to consume is equal to ____​(Enter your responses rounded to two decimal​ places.) Her marginal propensity to save is equal to _____(Enter your responses rounded to two decimal​ places.)

.53 .47

Suppose that the government gave each U.S. legal resident​ $10 but everyone decided to save the money and not spend it. In this​ case, the fiscal multiplier would be

0

In one​ year, a​ consumer's income increases by ​$300 and her savings increases by ​$180. Her marginal propensity to consume is equal to ____ Her marginal propensity to save is equal to ___

0.4 0.6

(7 points) Show the Keynesian goods market (AD-AS) and Labor market graphs at a long-run equilibrium. Using your graphs, show the short-run effect (move to new AD=AS point) of a decrease in net exports. Explain any shifts in curves as well as any movements along curves in your graphs. Explain the impact on GDP, prices, wages, and employment in the short run.

1 point for setting graphs up correctly1 point: AD shifts in by change in NX * (1/(1-mpc)) (or can say by NX times the AE multiplier)1 point: and show in graph½ point: AD<AS inventories rise ½ point: and firms want to decrease both GDP and P ½ point: To get GDP down, need less L and as L falls mpl rises so firms don't mind that the real wage is rising ½ point: As nominal wages unchanged but P falls½ point: show in graph movement along Ld½ point: say GDP down as L down (or can show new GDP2 and L2 in graph)½ point: and we move along AS to short run recession½ point: move along AD as P falls because NX rises back (or can say X up and M down, or can say "international effect" or "interest rate effect" or "wealth effect" without explanation of what those mean)½ point: As nominal wages unchanged but P falls½ point: show in graph movement along Ld½ point: say GDP down as L down (or can show new GDP2 and L2 in graph)½ point: and we move along AS to short run recession½ point: move along AD as P falls because NX rises back (or can say X up and M down, or can say "international effect" or "interest rate effect" or "wealth effect" without explanation of what those mean)

Two things that make AD for Keynesians different than for classical

1) long run relationships don't hold in the SR so sectors aren't linked via the circular flow----> makes changes in aggregate demand possible 2) households aren't rational economic agents: MPC never =0. ---> makes changes in aggregate demand big.

The increased federal budget deficit works through three channels:

1. Increased transfer payments such as unemployment insurance, food stamps, and other welfare payments increase the income of some households, partly offsetting the fall in household income. 2. Other households whose incomes are falling pay less in taxes, which partly offsets the decline in their household income. Because incomes do not fall as much as they would have in the absence of the deficit, consumption spending does not decline as much. 3. Because the corporation tax depends on corporate profits and profits fall in a recession, taxes on businesses also fall. Lower corporate taxes help to prevent businesses from cutting spending as much as they would otherwise during a recession.

Contributions to Real GDP Growth, 1929-1982

1.02% technology .56% capital 1.34% labor

multiplier equation

1/(1-MPC)

At a 7 percent annual growth rate in GDP per​ capita, it will take -- years for GDP per capita to double. ​(Enter your response rounded to one decimal​ place.)

10

Today, Social Security, Medicare, and Medicaid constitute approximately __ percent of GDP.

10

A lottery game offers a prize of $100,000 at the end of thirty years. If the interest rate is 6​%, the present value of this amount is ​$____.​

17411.01

If the private sector saves 5 percent of its income and the government raises taxes by ​$200 to finance public​ investments, total investment—private and public investment—will increase by ​$___.

190

Present value (3)

1The present value of a given future payment can be thought of as the maximum amount a person is willing to pay today in order to receive that future payment. 2As the interest rate increases, the opportunity cost of your funds also increases, so the present value of a given payment in the future falls. In other words, you could invest less money today in order to receive a future payment of K if interest rates are higher, therefore the present value (amount you would pay now for a guaranteed payment of K) is lower. 3As the interest rate decreases, the opportunity cost of your funds also decreases, so the present value of a given payment in the future rises.

The table below shows the initial cost and next year return for a variety of projects ITOF Inc. is considering for investment. Project Cost​ ($) Return​ ($) 1 100 103 2 100 110 3 100 108 4 100 104 5 100 107 If the current nominal interest rate is​ 6%, which of the following projects are​ profitable?

2,3,5

If the MPC is 0.500.50​, the simple multiplier will be equal to

2.0

If the nominal interest rate is 4.7​% and the inflation rate is 2.2​%, the real interest rate is ___​%.

2.5

US spends ____ times the OECD average

2.5

Experts estimate that in 2075 spending on these programs will be approximately __ percent of GDP.

22

If the MPC is 0.75​, the simple multiplier will be equal to

4

Progressive taxation, safety nets, and the skewed income distribution, result that over ___% of all income tax collection comes from the top _% of US wage-earners

50% 2%

If a project costs​ $100 and pays ​$106 next​ year, the maximum interest rate at which the present value of the investment exceeds its cost is __%

6

Social insurance taxes and individual income taxes together comprise​ _____ percent of total federal revenue.

80

Income taxes and social insurance taxes comprise approximately what percentage of federal​ revenues?

85

Half of taxpayers pay ____ percent of all income taxes

97.2

Secondary bond market prices- assessment of bond risk

A Low price means high risk but high return if it pays off Bond ratingsare professional assessments of bond risk AAA is the highest BB and lower in the alphabet are called "junk bonds"

aggregate supply curve (AS)

A curve that shows the relationship between the level of prices and the quantity of output supplied.

stagflation

A decrease in real output with increasing prices.

●Medicaid

A federal and state government health program for the poor.

●Medicare

A federal government health program for the elderly.●MedicaidA federal and state government health program for the poor.

Social Security

A federal government program to provide retirement support and a host of other benefits.

growth accounting

A method to determine the contribution to economic growth from increased capital, labor, and technological progress.The government measures Y, K, and L and then backs out the contribution from A (Technology) assuming a certain production function for GDP

multiplier-accelerator model

A model in which a downturn in real GDP leads to a sharp fall in investment, which triggers further reductions in GDP through the multiplier.

MBS

A mortgage-backed security is a CDO that is made up of mortgages in the housing market

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.

Rule of 70

A rule of thumb that says a number will double in 70/x years, where x is the percentage rate of growth.

subprime

A subprime borrower is one with a bad credit history

neoclassical theory of investment

A theory of investment that says that real interest rates, productivity, and taxes are all important determinants of investment.

long-run aggregate supply curve

A vertical aggregate supply curve that represents the idea that in the long run, output is determined solely by the factors of production (as in the classical and neo-classical models).

Mandatory Spending--Smaller entitlement programs:

About 11 percent of the budget is spent on SNAP (aka "food stamps"), income support for the disabled, UI (Unemployment Insurance), TANF (Transitional Aid for Needy Families), and commitments to veterans

Why does standard economic theory expect convergence in per-capita GDP?

According to standard theory, should poor countries be growing more quickly, less quickly, or at the same rate as rich countries?•Why has industrialization and globalization helped all countries?•Why has industrialization and globalization helped the rich countries more than poor ones? Does this explanation also explain the widening income distributions within countries?

KEYNESIAN VIEW OF THE FISCAL MULTIPLIER: SUMMARY

An increase in Government spending will cause a second increase in Consumption spending according to the marginal propensity to consume. If the mpcis large and wages are sticky, a $1 increase in government spending could result in a $2.50 increase in GDP Similarly, a temporary tax cut that increases spending will cause incomes to rise and lead to another round of spending increases according to the mpc. In sum, even small fiscal policies may have big economic impacts

Neo-classical theory----investment:

As the real interest rate declines, investment spending in the economy increases. This is a movement along Investment Demand (Id)

Although the textbook shows AS shocks in isolation (say from changes in tax policy, oil prices, productivity, or in the capital stock), that is a simplification and it is a bit misleading

As we know from the circular flow diagram, shocks to the supply side are also shocks to the demand side. If both AS and AD fall at the same time, the price effect is ambiguous. In fact, the classical model doesn't have much to say about nominal prices and stagflation may or may not be the result of a negative AS shock

Are Deficits Bad?No -

Automatic Stabilizers

Consumers in Country A have an MPS of 0.30.3 while consumers in Country B have an MPS of 0.20.2. Country ____ has the higher value for the multiplier.

B

As risk increases, lenders demand a higher rate of return

Banks charge higher interest rates Current stock prices fall Currently-issued bonds offer a combination of a higher coupon rate and a higher repayment price Secondary-market bond prices fall Credit Default Swaps (CDS's) get more expensive

The Stock Market and Investment Levels, 1997-2003

Both the stock market and investment spending rose sharply from 1997, peaking in mid-2000.

Fiscal Policy

Broadly defined as government taxation, redistribution (transfer payments), and Government purchases (this last one is the "G" in national income accounting)

Which of the following is not a component of aggregate​ demand? A. Exports B. Federal government expenditures C. Consumption D. Business taxes

Business taxes.

"Just over half (54%) of Americans surveyed in fall [2015] by Pew Research Center said they pay about the right amount in taxes considering what they get from the federal government, versus 40% who said they pay more than their fair share.

But in a separate 2015 survey by the Center, some six-in-ten Americans said they were bothered a lot by the feeling that "some wealthy people" and "some corporations" don't pay their fair share."

____ is the largest component of GDP (more than 2/3 of GDP).

C

consumption function equation

C = Ca+ by

In poor​ countries, the relative prices for nontraded goods​ (such as household​ services) to traded goods​ (such as​ jewelry) are ▼ more expensive cheaper than in rich countries.

CHEAPER--> All residents of the world may pay the same prices for traded goods such as​ jewelry, but, without international​ trade, the relative prices of nontraded goods in poorer countries may be considerably less. For​ example, household helpers may be cheaper in Pakistan than in the United States.

How would you test the brain drain theory???

Compare the types of jobs in developing countries with and without significant​ "brain drain." Compare wages in developing countries with and without significant​ "brain drain." Compare labor productivity in developing countries with and without significant​ "brain drain."

financial intermediation includes

Credit assessment Loan Assessment Monitoring Risk Deposit rate or "inter-bank rate" if they borrow from other banks instead of households

Are Deficits Bad? Yes-

Crowding Out

Entitlement programs now outstrip

Defense spending as the largest share of US federal outlays

Growth rates vs. per capita income graph

Each point on the graph represents a different currently developed country. Notice that the countries with the lowest per capita incomes in 1870 (shown along the horizontal axis) are plotted higher on the graph.In other words, the tendency was for countries with lower levels of initial income to grow faster.

Why is investing spending so volitale-->(Neo-)Classical view

Expectations about future mpkare sensible and derive from current information about productivity. Mistakes happen, but a reasonable approximation is that both I and AD move with long-run changes in LRAS. Volatility in Investment spending in this model is the result of optimizing decisions by firms that prefer to buy capital goods in "lumpy" ways, rather than a little bit at a time.

supply shocks

External events that shift the aggregate supply curve.

The good news about financial market bailoutsby governments: (3)

FDIC protection protects savers from bank failure FDIC protection may prevent bank runs, which may themselves cause financial crises Banking bailouts help preserve the links between savers and borrowers, which make it possible for firms to borrow money for capital improvements and lead to economic growth.

●contractionary policies

Government policy actions that lead to decreases in aggregate demand.

●expansionary policies

Government policy actions that lead to increases in aggregate demand.

Openness (free movement of goods, services, and money) is correlated in the international data with economic growth. Using the language and theory from class, briefly explain three economic theories behind why this relationship may be causal (i.e that openness causes economic growth).

Greater competition induces more innovations and forces countries to engage in creative destruction, which leads to new technologies and to shifts in the Production Function and to increases in GDP Larger markets create larger profits which creates more competition Greater ability to borrow from foreign countries and thereby increase domestic investment spending on capital goods, which increases the productive potential and shifts the production function and increases GDP

Growth accounting is a useful tool for

Growth accounting is a useful tool for understanding different aspects of economic growth. Using growth accounting​ methods, economists typically found the slowdown during the 1970s could not be attributed to changes in the quality or quantity of labor inputs or to capital deepening. Either a slowdown in technological progress or other factors not directly included in the​ analysis, such as higher worldwide energy​ prices, must have been responsible. This led economists to suspect that higher energy prices were the primary explanation for the reduction in economic growth.

what shifts the aggregate demand curve to the left?

Higher taxes, lower government spending, and a lower supply of money shift the curve to the left.

Suppose a foreign​ country, which had allowed the United States to export to it comma suddenly closed its market In this​ case, aggregate demand will

INCREASE because exports are directly related to shifts in aggregate demand.

Bush Administration

In 2001, President George W. Bush passed a 10-year tax cut plan in part to stimulate the economy. •After September 11, 2001, President Bush and Congress authorized new spending to stimulate the economy which had entered a recession. •This was followed by other expansionary fiscal policy

How would the predictions of the Keynesian accelerator model differ from that in part b?

In this case AD would fall more quickly than would AS or LRAS so we would know that prices would fall and output would fall below potential, employment would fall below potential; the real wage would likely fall but not by as much thanks to the fall in prices (holding nominal wages constant as in the Keynesian framework)

Paul Romer

Institutions matter, access to education and health care matter, degree of corruption matters, rule of law matters, etc •FYI See the World Bank Ease of Doing Business Index(Paul Romeris not a fan of the exact numbers in the Index, but it is likely the best measure out there)

Savings =

Investment internationally, not within any particular countryThe U.S. is a net borrower (domestic S < I), as are most European economies (not Germany!)

Suppose that a group of consumer activists claims that drug companies earn excessive profits because of the patents they have on drugs. The activists advocate cutting the length of time that a drug company can hold a patent to five years. They argue that this will lead to lower prices for drugs because competitors will enter the market after the​ five-year period. Do you see any drawbacks to this​ proposal?

It will reduce the incentive for drug companies to invent new drugs.

Economic growth is slower than it was a few decades ago, but it is not slow by historical standards. The post-war period may just have been unusual.

It's hard to know what economic growth should be! It is determined by growth in human capital (education), capital, and productivity. Both human capital and traditional capital investments are made when the returns are high, which happens when productivity growth is strong.

Modern fiscal policy came to be accepted during the early​ 1960s, in the presidency of

J F K

The​ Q-theory of investment was developed by

James Tobin

New Growth Theory

Modern theories of growth that try to explain the origins of technological progress.

technological process

More efficient ways of organizing economic affairs that allow an economy to increase output without increasing capital or labor inputs.

relatively volitale

Moves more than GDP—the swings up and down are both bigger for I than for GDP

procyclical

Moving in the same direction as real G D P.

Fiscal year 2015 began on

October 1, 2014

INVESTMENT SPENDING IS BOTH

PROCYCLICAL AND RELATIVELY VOLATILE

William Nordhaus

Pioneered methods measuring economic costs of climate change using scientific and mathematical models of temperature change forecasts for different parts of the world •Growth contributes to climate change (see next)

The U.S. economy witnessed federal budget surpluses in the late 20th century under

President Clinton

We'll assume households can do any of 4 things with their savings:

Put it in a bank Loan directly to a firm or household Buy bonds Buy stocks

Provision of a Safety Net

TANF again Unemployment and Disability Insurance Social Security Medicare Subsidies

Which of the following factors led the United States from federal surpluses at the end of the 1990s to deficits in the first decade of​ 2000?

Tax cuts combined with increased spending.

the coupon

The (usually annual) per-period return

European levels of per-capita GDP fell as a result of the two World Wars, but then their growth rate exceeded ours as they caught up, just as theory would predict

The US and Western Europe showed rapid productivity growth for 40 years after World War II (Western Europe grew a bit faster as it converged to US levels) and now growth rates have levelled off to historical norms.

budget surplus

The amount by which government revenues exceed government expenditures in a given year.

budget deficit

The amount by which government spending exceeds revenues in a given year.

The repayment price

The bond contract can be sold to anybody at any time

APPLYING THE CONCEPTS #1: How may global warming affect economic growth?

The effects of global warming on economic development are very complex •The effect of increases in temperature seem to be confined to poor countries •In Latin and South America, each 1 degree Celsius increase resulted in a 1.2 to 1.9 percent decline in per capita income •Exports also declined between 2.0 and 5.7 percent .•By deferring global warming into the future, poor countries may have time to develop and avoid the worst of the impact.

stock markets

The firm sells a share of itself rather than taking out a loan -No repayment is necessary -Stocks can be traded or sold to third parties

marginal propensity to consume (MPC)

The fraction of additional current income that is spent.

marginal propensity to save (MPS)

The fraction of additional income that is saved is (1-mpc)

Direct Lending

The individual saver earns the lending rateThe individual saver assumes all the intermediation costs and risks

What factors determine the costs firms must incur to produce output?

The key factors are • Input prices (wages and materials) • The state of technology • Taxes, subsidies, or economic regulations

human capital

The knowledge and skills acquired by a worker through education and experience and used to produce goods and services.

present value

The maximum amount a person is willing to pay today to receive a payment in the future.

P R I N C I P L E O F O P P O R T U N I T Y C O S T

The opportunity cost of something is what you sacrifice to get it.

autonomous consumption spending

The part of consumption spending that does not depend on currentincome.

short run in macroeconomics

The period of time in which prices do not change or do not change very much.

Securitization of CDO's

The practice of purchasing loans, re-packaging them, and selling them to the financial markets. Examples of these packages are called "collateralized debt obligations" or CDO's

multiplier

The ratio of the total shift in aggregate demand to the initial shift in aggregate demand.

consumption function

The relationship between the level of income and consumer spending.

Panel A shows an example of successful stabilization policy.

The solid line represents the behavior of GDP in the absence of policies. The dashed line shows the behavior of GDP when policies are in place. Successfully timed policies help smooth out economic fluctuations.

the spread between the lending rate (paid by borrowers)and the deposit rate (earned by savers)

The spread is counter-cyclicalThe spread shrinks as efficiency increases

The stock market is currently weak. What do we expect to happen to investment spending using Q theory? Is that consistent with your answers to b and c?

The stock market should be responding to real changes in productivity, which also shifts the Id curve, so both should fall or be weak together. Yes that is consistent with the answers to both b and c

Q theory of investment

The theory of investment that links investment spending to stock prices because stock prices are related to expected future productivity.

Households form expectations about their permanent income.

They attempt to borrow (save) when income is temporarily low (high) over the business cycle to keep C fairly stabile.

Also in the economic data: Widening of the income distribution has, on average, been bad for economic growth.

This affects convergence but is also cautionary for rich countries currently experiencing widening of the income distribution

If neo-classical economists have the forecast right, what impact should this type of productivity forecast have on prices, real wages, employment, and GDP? (you can either graph or refer to the model)

This would be fall in growth of AD, LRAS, AS and Ld, so real wages would grow less quickly and so would output. The impact on prices is ambiguous. Employment growth would slow

APPLYING THE CONCEPTS #7: Why are clear property rights important for economic growth in developing countries?

Throughout the developing world, property is often not held with clear title. Without clear title, property cannot be used as collateral for loans. • Result: The poor living on very valuable land may be unable to borrow against that land to start a new business. • Producing palm oil in Peru is very profitable, but it depends upon the ability to borrow funds. • Production of coca paste—an ingredient to cocaine—does not take as much time and does not depend on finance. • Switching farmers away from production of coca paste to palm oil also requires improvements in finance, which are very difficult without clear property rights.

So far, U.S. yields remain low historically, debt funding remains broadly available and many foreign purchasers retain large stakes. China and Japan still both own more than $1 trillion of U.S. debt, according to the U.S. data, and there are few signs that Treasurys are losing their cache as the world's most widely traded, extensively held safe securities.

Treasury yields serve as a reference rate for mortgages, business loans and other borrowing.Yet it is clear that the foreign pullback has helped fuel a bond selloff this fall, which has driven the 10-year yield to a recent 3.15% and has shaken the nine-year-long rally in U.S. stocks, and that continuing reductions in foreign appetite could further unsettle financial markets. Rising yields on Treasurys tend to hurt stocks by raising companies' and investors' borrowing costs and dimming the allure of dividend-paying stocks.

Labor productivity growth was lower from 2007−2013 compared to recent years. ▼ False True

True-->From 1947 to the worldwide oil crisis in​ 1973, labor productivity grew rapidly. Productivity growth fell in the remainder of the 1970s and slowly increased over the next two decades. Since​ 2007, productivity growth has also slowed from recent​ trends, partly due to the recession.

Tax cuts and stimulus packages designed to stimulate the economy after the recessions of 2001 and 2008 resulted in

U.S. deficits again.

ECONOMIC GROWTH—WINNERS AND LOSERS? In the Solow balanced growth model technological progress increases both the productivity and earnings of both capital and labor

Until the mid-1990's, mechanization shifted workers into the production of robots. Current technological progress seems however to be labor-replacing, as new technologies replace workers with app's, which are developed by workers with different skill sets than the ones losing their jobs The income distribution is widening between those that can afford to save (and are therefore earning high rates of return on savings) and those than cannot. Outside the top 0.5% of wage-earners, returns to labor seem well-predicted by schooling, major field of study, and experience. The widening and hollowing out of the income distribution may therefore be temporary if there is equal access to education and employment in high-demand fields

leverage

Using borrowed funds to purchase assets.

The growth rate of real GDP per capita equals the growth rate of real GDP minus the growth rate of the population. If the growth rate of the population is 2 percent per​ year, how fast must real GDP grow for real GDP per capita to double in 14 ​years? nothing percent. ​(Enter your response as an​ integer.)

7

A key worry for investors has been the U.S. budget deficit, which stands at its widest level in six years in the wake of tax cuts and other fiscal-stimulus measures enacted by the White House in 2017. Moody's Investors Service expects the budget gap to grow to

8% of gross domestic product by 2028, from less than 4% now, further weakening the U.S. fiscal position.Adding to the negative chatter about U.S. bonds: Some central banks, sovereign-wealth funds and global investors may be shedding dollars as they attempt to diversify their holdings, while others may have deemed their dollar reserves sufficient to weather the risk of economic turmoil.

A negativenegative supply shock temporarily ▼ raises lowers output ▼ above below full employment and ▼ raises lowers prices. After the negativenegative supply​ shock, real GDP is ▼ lower than higher than potential GDP. This implies that unemployment is ▼ falling rising ​, driving wages ▼ down up . This results in a ▼ leftward or upward rightward or downward shift of the​ short-run aggregate supply curve.

A negative supply shock temporarily lowers output below full employment and raises prices. After the negative supply​ shock, real GDP is lower than potential GDP. This implies that unemployment is rising ​, driving wages down . This results in a rightward or downward shift of the​ short-run aggregate supply curve.

short-run aggregate supply curve

A relatively flat aggregate supply curve that represents the (neo) Keynesian idea that prices and wages do not change very much in the short run and that firms adjust production (and the number of workers they hire) to meet demand

supply-side economics

A school of thought that emphasizes the role that taxes play in the supply of output in the economy.

Expectations about the impact on future taxes

A stimulus that results in increased federal borrowing will eventually imply either cutbacks or tax increases. Households and corporations expecting the current positive stimulus to be offset by a future negative effect will know that their permanent income (lifetime income) is unchanged and this may dampen the multiplier effect on current consumption spending.

Why are stabilization policies difficult to implement​ effectively?

A. Forecasting the right amount of fiscal policy is problematic. B. It takes time for economic policy makers to formulate and implement new policy. C. Fiscal policies take time to operate.

Economic historians have found that the average height of individuals in both the United States and the United Kingdom fell during the​ mid-nineteenth century before rising again. This was a period of rapid industrialization as well as migration into urban areas. What factors do you think might account for this fall in​ height?

A. Health conditions in urban areas were worse than in rural areas. B. Industrialization did little to reduce malnutrition. C. Resources were invested in physical capital instead of human capital.

Why might entrepreneurs and firms use banks for loans instead of going directly to​ savers?

A. Individual investors may not be savvy enough to evaluate the risks of making a loan. B. It is time consuming to pitch an investment idea to many investors instead of one bank. C. Individual investors may ask for a high rate of interest to compensate for their risk.

Which of the following may influence technological​ progress?

A. The scale of the market. B. Research and development spending. C. Monopolies.

Although we might admire someone who decides to attend medical school at the age of​ 50, explain using human capital theory why this is so rare.

A. Younger students have more time in which to earn higher wages after graduation. B. Younger students face a lower opportunity cost of forgone earnings while in school.

Consider this​ statement: Since capital is subject to diminishing​ returns, an increase in the supply of capital will reduce real wages. This statement is wrong because an increase in the supply of capital will

A. increase the marginal benefit from employing labor and therefore increase the demand for labor and real wages.--> Increase the An increase in capital shifts the production function upward because more output can be produced from the same amount of labor. In​ addition, firms increase their demand for labor because the marginal benefit from employing labor will increase. The increase in capital raises the demand for labor and increases real wages. That​ is, as firms increase their demand and compete for a fixed supply of​ labor, they will bid up real wages in the economy.

​"If the real interest rate was​ zero, it would be a financially sound decision to level the Rocky Mountains so that automobiles and cars would save on gas​ mileage." Putting aside ecological​ concerns, this statement is true​ because:

A. investment is a function of the real interest rate. B. you could borrow the funds with no opportunity costs. C. the benefits of gas savings would offset the cost of leveling the mountains.

"When real interest rates are​ high, so is the opportunity cost of​ funds." This statement is true​ because: (3)

A. the real interest rate is important when considering the cost of funds. B. the higher interest rates make it more costly to use or borrow funds. C. the opportunity cost of funds is the interest rate.

In an economy with no government sector or foreign​ sector, saving must equal investment because

A. total income is equal to consumption and saving. B. total income is equal to total demand. C. total demand is equal to consumption and investment.

Neo-Keynesians believe ______ cause most business cycles and that the economy is out of equilibrium during those periods.

AD shifts The "circular flow" is violated and there is a potential for Government spending to stimulate AD, hiring workers who, because of coordination failures, have been laid off rather than given pay cuts

Panel B shows the consequences of ill-timed policies.

Again, the solid line shows GDP in the absence of policies and the dashed line shows GDP with policies in place. Notice how ill-timed policies make economic fluctuations greater.

_______ demand is the total demand for goods and services in an entire economy.

Aggregate

Mandatory Spending--Largest entitlement programs:

All other things being equal, both Social Security and Healthcare expenditures will rise because the government has already committed to those future expenditure increases. Both "entitlement" program expenditures support the retirees that paid into the system as workers as well as their dependents.

All other things being equal, explain why labor income tax cuts may have unintended negative consequences for the economy.

All other things being equal, lower tax revenue means less government savings , which causes crowding out of the private sector

ARBITRAGE AND THE HOUSING BOOM LEADING TO THE GREAT RECESSION

An MBS made up of subprime loans might not be risky if it is well diversified. There had never in US history been a nation-wide collapse in the housing market, nor of course in the world housing market. Investment banks (financial intermediaries for firms) bought lots of MBS's.Interest rates were low, housing prices were high, so the present value of an MBS was greater than the cost of the mortgage. Good deal! And not risky because it was diversified! Arbitrage caused investment banks to leverage (borrow) at low rates and buy MBS's made up of subprime loans—slightly risky on expectation but with collateral (CDO's with AAA credit ratings)When the housing crisis went global, investment banks owed money (they were leveraged) that they couldn't pay back (default rates on the MBS holdings were crazy high) => a financial crisis.

ECONOMIC CONVERGENCE: The theory says that economic growth should cause aggregate income levels to converge

Assuming equal access to technology and to capital markets, everyone country should be able to be equally rich in per capita terms. Poor countries should converge toward rich-country levels as financial institutions develop and as they adopt technologies used in richer countries. Poor countries should grow faster than rich ones as they catch up in levels.

The Clinton Administration

At the beginning of his administration, President Bill Clinton proposed a "stimulus pachage" that would increase aggregate demand, but was defeated by Congress.•Later, President Clinton, along with a Republican-controlled Congress, passed a major tax increase to balance the budget and brought the Federal budget into surplus.

All other things being equal, explain why international trade (free trade agreements) may be good for aggregate economic growth.

Can say increases competition and encourages greater efficiency, or increase markets for monopolies and thereby increases R and D to get the monopolies, or that increases exchange of ideas which increase productivity/efficiency, etc

APPLYING THE CONCEPTS #3: How can we use economic analysis to understand the sources of growth in different countries?

China and India are the two most populous countries and have also grown very rapidly in recent years.From 1978 to 2004, GDP in China grew at the rate of 9.3 percent per year while India's GDP grew at a lower rate of 5.4 percent per year. Economists Barry Bosworth from the Brookings Institution and Susan Collins from the University of Michigan used growth accounting to answer this question. ▪China's rapid growth was caused by more rapid accumulation ofphysical capital and more rapid technological progress. ▪China invested much more in physical capital and was able to increase its technological progress at a more rapid rate.

Government: Longterm goals-->

Correction of (mis?) perceived market failures

The evidence for convergence is mixed

Corruption, restrictive trade policies, price controls, and political/social unrest can both result on and reinforce slow economic growth, suggesting the importance of institutions as hidden nontraded inputs into the aggregate production function.

GOVERNMENT: GOALS OF TRANSFERS (2)

Create equal opportunities for advancement Provision of a Safety Net

After the Great​ Depression, depositors panicked and removed their money. ​_______ was a government program created to prevent bank runs from occuring in the future.

Deposit insurance

Stabilization Policy—based on Classical model (these are really long-term policies used again in downturns)

Develop infrastructure (education, transportation, support of commerce) Cut corporate and payroll taxes to stimulate K and L

There are two sources of expected return from stocks:

Dividends Retained Earnings

Economic historians have found that the average height of individuals in both the United States and the United Kingdom fell during the​ mid-nineteenth century before rising again. This was a period of rapid industrialization as well as migration into urban areas. How would you evaluate economic welfare during this​ period?

Economic welfare decreased as measured by average height.

SUPPLY-SIDE ECONOMICS: SUMMARY`

Economists generally agree that taxes distort behavior, and that it is, all other things being equal, best not to tax an activity unless you wantto distort its behavior. Otherwise tax distortions are one of the "costs" in the cost-benefit analysis associated with government outlays. "Supply-side economics" is not a branch of economics per se but is a policy approach by people who believe either or both of the following: We are on the "wrong side" of a Laffer curve and a tax cut would both stabilize AD and raise tax revenueTax cuts to business and the wealthy will "trickle down" to the rest of the economy through increased hiring

APPLYING THE CONCEPTS #4: How do you measure the technological revolution?

Economists have made considerable progress in adapting growth accounting to this new environment. The idea they use is to create a measures of "intangible" capital based on expenditures on research and development, marketing, design and customer support. Once they have this measure of intangible capital, they can use it along with conventional measures of capital and labor to understand the sources of economic growth. Estimates by economists Carol Corrado and Charles Hulten suggest that intangible capital is an important source of economic growth. They found that in recent years, the contribution from intangible capital actually exceeded the contribution from traditional or tangible capital. Together, the two capital measures also contributed more to economic growth than technological progress.

Economist Arthur Laffer argued what theory on tax​ rates?

Excessivly high tax rates lead to lower government revenue.

CLASSIC VIEW OF THE FISCAL MULTIPLIER: SUMMARY

Expectations may undermine the effectiveness of expansionary policies Temporary tax cuts and/or spending increase force governments to increase current borrowing, which must be later repaid with either or both a temporary tax increase or spending decrease. Thus a current stimulus implies future austerity. If households and firms plan for the future, they will do their best to save the positive impact of current stimulus in order to be ready to deal with the expected future austerity. Moreover, government borrowing may drive up interest rates, lowering both C and I Expansionary fiscal policies may be offset with negative multiplier effects, with little or no economic impact

The Wall Street Journal article argues that decreased foreign demand for US government bonds is at least partly responsible for rising bond yields, rising borrowing costs for firms, households, and government, and for the fall in the stock market. Explain how that works.

Falling demand for US government bonds reduces the trade price of bonds on secondary bond markets, which raises their yield.A higher yield on old bonds traded on the secondary bond market forces newly-issued government bonds to also offer a higher yield, which raises the cost of government borrowing at the same time that it offers a higher return to those that lend to the government. This is arbitrage theory at work (all rates move together). Corporations trying to raise money by selling corporate bonds must compete with government bonds in terms of the rate of return they offer to savers, and so yields on corporate bonds rise too, which reduces borrowing by corporations and Investment spending is reduced—this is one of the ways that the mechanics of "crowding out" works (G goes up and I goes down in response to the interest rate effect). This is arbitrage theory at work ( all rates move together). Firms might try to sell shares of themselves rather than have to repay corporate bonds that are so expensive for them, but savers will be unwilling to buy stock shares (shares of firms) at a high price because bond yields offer a better return—demand for stocks falls and the average price of stocks (average price of shares of firms) falls (stock market falling means an index of the average price of stocks traded has fallen). This is "arbitrage" theory at work (all rates move together). Finally, households that want to take out loans for new cars, new houses, education, health care costs, etc, will have to offer a competitive interest rate on those loans or else savers will not be interested in lending to them. The cost of borrowing for consumer loans rises along with the cost of borrowing for government loans (and with the cost of borrowing for new investment goods)—again this is arbitrage theory at work. Consumption spending is also reduced (this is another example of the mechanics of why "crowding out" happens via the interest rate effect).

Economists who have studied economic growth find strongstrong evidence for convergence among countries between 1980 and 2000. T or F

False--> Economists have found convergence among currently developed countries such as the United​ States, France, and Japan.​ However, economists have not found convergence between currently developed countries and less developed countries such as​ Pakistan, Zambia, and Zimbabwe.

There is clear evidence that poorer countries in the world are converging in per capita incomes to richer countries. T or F

False-->There is debate about whether poorer countries in the world are converging in per capita incomes to richer countries.

deposit insurance

Federal government insurance on deposits in banks and savings and loans.

WHY IS INVESTMENT SPENDING SO VOLATILE? (Neo-)Keynesian view

Firms' expectations about future mpk behave as though driven by "animal spirits." These irrational swings in AD are the primary source of temporary deviations from LRAS (business cycles).

Overseas investors, traders and central bankers are buying fewer Treasurys, a potential turning point for a $15 trillion market at the center of global finance and economics.Foreigners increased their holdings of Treasurys by $78 billion in the first eight months of 2018. That is just over half of what they bought during the same period last year and accounts for a much smaller share of Treasury issuance, as the government steps up the size of regular bond auctions to fill a growing U.S. budget gap.

Foreign buyers now hold 41% of outstanding Treasury debt, their lowest share in 15 years, down from 50% as recently as 2013, according to U.S. Treasury data.

All other things being equal, explain why international trade (free trade agreements) may have unintended negative consequences for the economy.

Frictions (or can say skills mis-match) in labor markets keep the import-competing sector from easily moving to the expanding export sector, so the income distribution widens

social security, gross compensation...

Gross compensation is taxed at roughly 13%, with the worker share about 6%. The social security payroll tax disappears at about $120,000/year in current dollars (payroll taxes fall 6 percentage points at $120k). As workers earn more they pay higher average income taxes but lower average social security taxes. Social security payments in retirement are higher for those that paid more into the system. There is both a minimum "wage" in social security and also, because of the contribution limit, a maximum.

Using Economic Growth Accounting and an Example

Growth accounting is a useful tool for understanding different aspects of economic growth. •As an example, economic growth slowed throughout the entire world during the 1970s. •Using growth accounting methods, economists typically found the slowdown could not be attributed to changes in the quality or quantity of labor inputs or to capital deepening. •Either a slowdown in technological progress or other factors not directly included in the analysis, such as higher worldwide energy prices, must have been responsible. •This led economists to suspect that higher energy prices were the primary explanation for the reduction in economic growth.

APPLYING THE CONCEPTS #5 How do varying political institutions affect economic growth?

Growth can, and has, occurred in both authoritarian and participatory governments.Transformative economic growth like the Industrial Revolution usually requires participatory institutions. Sustained technological progress is disruptiveand authoritarian regimes have difficulty dealing with the change. Patent laws, intellectual property rights, and rule of law are needed to protect and encourage investors and innovators Historical evidence suggests that lacking monetary incentives, innovation and growth tend to stagnate. Monetary incentives include socio-economic mobility, competition, and (temporary) monopoly rent-seeking to encourage patent development

Higher saving leads to ▼ lower higher gross investment and will tend to ▼ decrease increase the stock of capital available for production and result in ▼ less more depreciation because there is ▼ less more capital to depreciate.

Higher saving leads to higher gross investment and will tend to increase the stock of capital available for production and result in more depreciation because there is more capital to depreciate.---> The stock of capital increases with any gross investment spending but decreases with depreciation. As capital stock items such as buildings and equipment get older​ (depreciate), they wear out and become less productive. New investment is needed to replace the buildings and equipment that become obsolete. Higher​ saving, which leads to higher gross​ investment, will tend to increase the stock of capital available for production. As the stock of capital grows there typically will be more depreciation because there is more capital​ (building and​ equipment) to depreciate.

___is a much smaller share of GDP (less than 1/5 of GDP) but it is very ______. Big swings in I lead to big swings in AD—hence the term business cycle to describe movements in GDP

I volitale

U.S. companies said they are tempering the effects of escalating tariffs with China through price increases or changes to their supply chains, but they warn investors that the picture could worsen next year. Tariffs have slowed U.S. timber and grain exports, raised the cost of imported clothes hangers and heavy-equipment materials, and compressed profit margins for computer chip and tool makers, among other effects, according to an analysis of results and comments from third-quarter earnings. While the negative impact is widespread, it's so far mostly modest, Theo Francis reports.The tariff concerns come as the recent run of robust profit and sales growth shows signs of slowing. Analysts and economists warn of still-slower earnings growth next year. Consider Exhibit 2. Would this best be modelled as a Keynesian negative AD shock or a neo-classical decline in potential output? Explain your point of view. Is there anything policymakers can do about the impact this might have on the aggregate economy? What do you think would be the best policy response? Use the economic theory and language from class to carefully explain your argument.

If AD then AD falls as NX falls exogenously (result of US policy and foreign retaliation, both of which are exogenous). This fall in AD happens in either the Keynesian or neo-classical story, but in the neo-classical story there may also be a fall in LRAS because of reduced efficiency and less competition—that is the source of "opinion" in the question. If they think it is purely temporary fall in AD then an increase in G or cut in taxes could return the economy to equilibrium, but of course so would ending the tariffs and trade disputes that started the problem and that is also a policy response.

The bad news about financial market bailouts by governments:

If a financial intermediary knows it will be rescued if it engages in risky behavior, there is no downside risk to engaging in risky behavior. "Moral hazard" occurs when insurance—like FDIC and other bailouts—causes risky behavior to increase. In this case the taxpayer gets stuck with the bill for more bailouts, so there are fiscal effects as well as general financial effects.

Why does economic theory predict that standards of living across regions of the world should converge over time? What kinds of countries show signs of convergence and what kinds of countries do not?

If there is free movement of money to pay for capital goods, and free movement of ideas, then the only thing that should be different across countries is their size; standards of living should be the same. Standards of living became very different in different parts of the world after the industrial revolution, but they should start converging now that all countries can see the institutions needed for growth and are more open to trade and financial flows. Countries that have shown signs of convergence are ones that have opened their markets to trade and free-flows of ideas and money—this is partly the correlation between openness and growth seen in the data. Some countries have been held back by corruption. Unequal effects of climate change caused by relative wealthy countries disproportionately negatively affecting relatively poor countries will increasingly become a contributing factor.

Obama Administraiton

In 2009, President Obama and Congress enacted the largest stimulus package in U.S. history. •The stimulus was controversial in both size and composition.

International trade effect

In an open economy, a lower price level will mean that domestic goods (goods produced in the home country) become cheaper relative to foreign goods, so the demand for domestic goods will increase.

Firms raise money to buy investment goods in financial markets

In both neo-Keynesian and neo-classical models, firms buy new capital goods (make investments) so long as the expected marginal productivity of capital (mpk) is at least as great as the marginal cost.Remember: Through arbitrage, we can represent the expected return to lenders as the real interest rate.

Federal receipts US income tax rates are not high by either historical or international standards. So why are people so angry about taxes?

In part because the system is so complicated, and the complication rewards the wealthy that can afford good tax advice and who can afford to buy things that can be deducted (like big houses). In part because everyone fears taxes will have to go up and they are putting up defenses. In part because hard-working people are angry about paying taxes to support non-working people at the same time that they are worried that they are about to become non-working people.Although the US economy looks good on paper, people are anxious: will they be replaced by robots or will they lose their jobs to workers in foreign countries who are even cheaper than robots? will their retirement income fall by 23% because social security is under-funded through no fault of their own? If so, how can they hope to get a job in their late sixties? Will the house they put all their savings into suddenly become worthless as happened in 2008? Is there anything safe to do with savings? Is there anything safe at all?

If wages are slow to adjust and it is also true that households behave as though they are (rationally) expecting a future tax increase

In this case although wages are sticky, there may be either no or only a small shift in AD because mpc should be close to zero (households spend out of lifetime income, not temporary changes in income) and the exogenous part of C (that depends on the future) falls; C down and G up. Small change in AD means small change in both P and GDP and employment. Note that in order for the Keynesian business cycle to "work" the joint assumptions that households aren't forward looking AND that wages are sticky (workers or firms prefer unemployment to wage adjustments or can't coordinate around wage adjustments) has to hold

If wages are slow to adjust and it is also true that households do not at all behave as though they are (rationally) expecting a future tax increase

In this case mpc is big the multiplier is big so there is a big shift in AD. The case looks like case "c" but is even bigger—the bigger the multiplier effect the bigger the business cycle swing (assuming workers/firms prefer unemployment to wage adjustments or somehow can't coordinate around wage adjustments)

capital deepening

Increases in the stock or quality of capital per worker.

What is the difference between inside lag and outside​ lag?

Inside lag is the time it takes to formulate a​ policy, outside lag is the time it takes for the policy to work.

Standard theory

Investment spending (I) today affects the future capital stock (K). Investments today are made until the expected marginal productivity of capital (mpk) equals the cost of capital (cost of borrowing to buy more K).

APPLYING THE CONCEPTS #2: Is there a necessary tradeoff between equality and growth?What is the connection between inequality and economic growth?

Is there a trade-off such that higher growth can only occur if there is increased inequality. Recent research suggests that this may not be the case—equality may be beneficial to economic growth.Andrew Beg and Jonathan Ostry explored the factors that determined why some countries had longer spells of sustained growth than others. Almost all countries can begin to grow, but it is more difficult to sustain growth. What they found was that when there was more equality, spells of growth within a country tended to last longer. Why might equality have a beneficial effect? The authors speculate that when there is more equality governments may be able to have enough power and authority to make the tough choices to sustain growth. Growth and equality could, however, be possibly caused by some common factor. For example, well-functioning markets for credit and loans may lead to both more growth and more equality. The good news is that it does not appear necessary to create inequality in order to promote growth.

Who developed the theory of creative destruction​?

Joseph Schumpeter

present value equation

K/(1+i) ^t

Economists agree about the long run and about long-run policy goals.

LRAS is determined by A,K, and full employment—there is just disagreement over both the sources of and SR adjustments to business cycle shocks

All other things being equal, explain why labor income tax cuts may be good for the aggregate economy.

Labor income taxes may distort labor supply, so removing labor taxes may increase employment (or can say increase labor input and therefore GDP, or can say increase real-wages)

____________ measures the output per hour of work.

Labor productivity

Berkshire Hathaway Inc. BRK.B 0.34% repurchased $928 million of its stock in the third quarter, a rare move that indicates Chairman Warren Buffett sees a dearth of appealing investment options for his company's large cash pile.It is the first time Berkshire has bought back stock since 2012. The decision, announced in a quarterly filing Saturday, illustrates the scarcity of attractively priced projects and deals that can satiate yield-hungry investors and firms more than nine years into a bull market. A legendary value investor best known for striking deals when prices are low, Mr. Buffett has struggled to find large investments that aren't overvalued. Berkshire hasn't made a major acquisition since it bought Precision Castparts Corp. for about $32 billion in 2016. Mr. Buffett, whose moves are widely watched for what they could mean to broader markets, is the latest to join in the buyback boom: Stock repurchases by S&P 500 companies hit a record in the second quarter, according to S&P Global Market Intelligence. 1. Consider Exhibit 1—an excerpt from an article in the Sunday, November 4, Wall Street Journal. In the exhibit it indicates that Warren Buffet prefers to buy back his own stock rather than put more savings into new Investment spending. a. What does this suggest about Warren Buffet's productivity growth (A) forecast?

Low productivity forecast, less Investment spending and fewer markets with mpk>r

Show the effect of a slowdown in population growth (Ls shifts left) on LRAS, AS, and AD assuming the economy moves immediately from one long-run equilibrium to another. What will happen to real wages, employment, GDP, nominal wages, and the price level? Explain all shifts in curves.

Ls shifts left => real wages rise and the natural rate of employment falls.Both AS and LRAS shift left as there is now less output at any price in both the short run and long run (potential output falls).AD shifts left as there are now fewer consumers (C down) at any price.GDP falls but the change in the price level of unknown. Although w/p is known, if the change in P is unknown the change in w is unknown.

Federal outlays growth (ALSO LOOK AT CHAPTER 10 2018 FEDERAL BUDGET)

Mandatory outlays in the form of entitlements are large and increasing.

In each case, briefly explain the impact on both GDP and P of an increase in Government spending that is paid for with government borrowing. a. In the long run (classical model) and there is no impact on Investment spending

No change in AD as there is nothing in the question about A, K, or L. Therefore if G goes up then C and/or NX go down by the same amount. No change in AD, no change in either P or GDP

Create equal opportunities for advancement (4)

No debtors' prisons (bankruptcy laws) Medicaid Temporary Assistance for Needy Families (TANF) Financial Aid Scholarships

Suppose a country that had balanced trade began to run a trade deficit. At the same​ time, consumption as a share of GDP increased but the investment share did not. Do you think there was an increase in capital​ deepening?

No, because​ consumption, not​ investment, has fueled the trade deficit.

Suppose you had a large unpaid balance on your credit card and were paying a high rate of interest. You then received a​ one-time tax rebate from the government and decided to pay down the balance on your credit card. If there were many others like you in the​ economy, would the tax cut be an effective​ stimulus?

No, since debt reduction would not stimulate consumption.

is health insurance free to employees?

No. Holding total compensation​ constant, if benefits such as health insurance​ increase, then wages must decrease.

Non-discretionary Spending:

Obligations to which the government has previously committed This includes Entitlement Programssuch as unemployment insurance, disability insurance, social security, veterans' benefits, government worker pensions, agricultural price supports, and both Medicareand Medicaid

How do fluctuations in energy prices affect investment decisions by firms?

One important way volatility of oil prices can hurt the economy is by creating uncertainty for firms making investment decisions.Consider whether a firm should invest in an energy-saving technology for a new plant:• If energy prices remain high, it may be profitable to invest in energy-saving technology.• If prices fall, these investments would be unwise.• If future oil prices are uncertain, a firm may simply delay building the plant until the path of oil prices are clear.When firms are faced with an increasingly uncertain future, they will delay their investment decisions until the uncertainty is resolved.

Using Growth Accounting: Labor productivity

Output per hour of work (or labor productivity) is a simple measure of how much a typical worker can produce given the amount of capital in the economy and the state of technological progress. From 1947 to the worldwide oil crisis in 1973, labor productivity grew rapidly. Productivity growth fell in the remainder of the 1970s and slowly increased over the next two decades. Since 2007, productivity growth has also slowed from recent trends, partly due to the recession. Economists have used growth accounting to help explain these trends in productivity growth in the United States. Economic research suggests that the oil shocks in the 1970s reduced technological progress but the information revolution in the 1980s and 1990s led to a resurgence of technological progress.

The expression "There ain't no such thing as a free lunch" is used to convey the idea that everything has a price. Because macroeconomics is concerned with the whole economic environment and not just the welfare of individuals in particular sectors of the economy, we in our study of macro-economics become acutely aware of the truth of that expression. Explain how recent policy changes demonstrate that maxim (expression), and also give your opinion about whether we might not net out in the long run—will there be a "free lunch" aspect or will things be worse as a result of recent policy changes? Or will all of this blow over in the long run with no long run effects? Explain your answer, using the language and theory from class.

Over 2018 we've seen government policy having a positive stimulating effect on Investment spending (shift in Id after the tax cut) and a positive stimulating effect on the import-competing sector. We've also seen that these gains didn't come for free—increased government borrowing caused by the tax cut and military spending increases has forced government bond yields to go up, which has raised the cost of borrowing for firms (movement left along Id as rates rise) and had a negative effect on firms that import (higher costs) and export (facing foreign retaliatory tariffs).The long-term effect of government borrowing is unlikely in my opinion to affect long-run productivity, which is the primary driver of economic growth, but the damage to confidence in international markets, international treaties, and international supply chain management will likely have a negative impact on economic growth for many years to come because it will reduce the ability to efficiently manage the supply chain for firms and keep their costs down and it will reduce the gains from research and development by reducing the size of sales and it will also protect the country from competition, which reduces competitive pressures and reduces the incentive to innovate.

bank run

Panicky investors simultaneously trying to withdraw their funds from a bank they believe may fail.

With secure land​ titles, parents can work outside the home​ (rather than guarding their​ property) and earn higher incomes. Explain why this might reduce child labor.

Parents with more income tend to rely less on their children for financial support. Parents can borrow against their property to purchase substitutes for their​ children's labor such as new machinery. Parents will be more willing to make​ long-term investments to improve their lives.

The economist who coined the phrase​ "animal spirits" to refer to investment spending by firms was

Paul Samuelson.

Discretionary Spending:

Purchases or Transfers not previously committed/contracted

In recent​ years, total compensation of employees—including benefits —has ​grown, but​ wages, not including​ benefits, have not. Explain why this may have​ occurred, taking into account that many employers provide health insurance to their employees and​ health-care costs have grown more rapidly than GDP.

Real hourly earnings can only increase if output per worker increases more than compensation in benefits.

ECONOMIC GROWTH—BIG PICTURE Piketty(and others): Recent data don't support balanced growth

Recent technological progress seems to be having an unbalanced effect on factors of production Returns to some types of labor skills are both higher and growing faster than returns to other types of labor skills Returns to capital are both higher and growing faster than average returns to labor

All other things being equal, should a slowdown in Investment spending be good or bad for the US trade balance? Explain briefly.

S-I = NX so holding S constant a fall in I reduces our borrowing from foreigners (S-I goes up) and NX goes up.

Any other changes in labor markets shift ...

SRAS (i.e. changes in nominal wages, K, payroll taxes, or technology all shift SRAS)

Neo-Classical economists believe ______ ____ ______ shifts cause most business cycles.

SRAS and LRAS Government spending crowds out the private sector if used to "stabilize" AD. This can make recessions worse if G crowds out capital markets so that I, K, and LRAS fall

In the long run (classical model) and there is no impact on NX

Same as in answer a, but now it is possible that I falls and that K also falls, so LRAS could fall as result of crowding out of private investment. The impact on P is unknown—AD could fall by the same amount as LRAS (no change in P) or by more (P falls) or by less (P rises)

Why is GDP per capita a good measure of economic welfare?

See the Gapmindervideo on Canvas showing the relationship between economic growth and life expectancy

Which of the following is an entitlement​ program? A. Personal consumption expenditure B. Social Security spending C. Private investment spending D. Personal income taxes

Social Security spending

Payroll taxes include

Social Security, Unemployment Insurance (UI), Medicare support, and disability insurance

Federal outlays: The biggest increases are in (2)

Social security and Medicare spending.

Growth accounting measure of technology A is known as the ______ _______ after Robert S., who developed the method

Solow residual

Induced Innovations

Some economists have emphasized that innovations come about through inventive activity designed specifically to reduce costs. This is known as induced innovation.

Government: Longterm goals--> Correction of (mis?) perceived market failures (8)

Subsidize education Subsidize research and development Development of infrastructure Auto and Health Insurance Mandates Protection of property rights, maintenance of legal system Environmental regulation Public safety, homeland security, national defense Supervision, regulation, support of commerce

How can understanding the concept of present value help us evaluate an annuity?

Suppose you and your employer both had set aside funds for the day you retire at age 65. Just before you retire, your employer offers you the following options: 1) You can have the $500,000 that was set aside, or 2) the firm would take the $500,000 and purchase you an annuitycontract---a financial instrument that would pay you a fixed annual payment of $35,000 per year as long as you live.•The first step in making this decision would be to calculate the present value of the annuity payments and compare it to the $500,000. Of course,, you do not know for sure how long you would live, so you would need some estimates of the probability of surviving at each age into the future. You would multiply that probability by the yearly annuity payment to obtain an expected annuity payment for every future year. Finally, you could need to choose an interest rate and calculate the expected present value of the annuity payments and compare it to the $500,000.•Hopefully, your firm offered you a well-price annuity. But the decision is still yours. The annuity would be a better deal for you if you were healthier than average and expected to live longer than the average person. On the other hand, if you had poor health, it would not be a good idea.

automatic stabilizers

Taxes and transfer payments that stabilize GDP without requiring policymakers to take explicit action.

Economic growth means there is more stuff per person

That can only happen if we producemore stuff per person, which can only happen if workers are more productive (workers either have more capital to work with or there is technological progress)

US corporate taxes were, before the December 2017 tax reform, higher "on paper" than in other similarly-developed economies, but the after-deduction and after-special-exemption "effective corporate profits tax rate" was only slightly higher than elsewhere for most types of firms.

The December 2017 corporate tax "cut" made the tax code more transparent, reduced the effective tax at least a little (and in some cases a lot) for many high-income firms. Regional banks were the group/industry that benefited most from the tax reform.

Bonds rallied Tuesday as worries about global growth and a downbeat outlook for U.S. corporate earnings dragged equities lower.

The Dow Jones Industrial Average lost around 1% and the 10-year yield, which falls as bond prices rise, retreated from its 2018 high of roughly 3.23% hit earlier this month. Yet the yield still held in its recent range above 3.1%. "Yields are rising to reflect a risk premium, rather than healthy growth," said Mark McCormick, North American head of foreign exchange strategy at TD Securities. "People are concerned about how reliable a store of value the dollar is right now."

By contrast, many believe the dollar's value largely reflects monetary policy expectations in the U.S.:

The Federal Reserve has raised rates eight times since 2015, and policy makers have penciled in four more increases by the end of 2019.As a result, hedging dollars is expensive: Foreign investors must pay 3% on an annualized basis to hedge against fluctuations of the dollar, making the trade unprofitable for many.

Suppose the economy goes into a recession. The political party in power blames it on an increase in the price of world oil and food. Opposing politicians blame a tax increase that the party in power had enacted. If the recession turns out to have been caused by a tax increasea tax increase​, all except one of following statements become true. Which is not​ true? The aggregate supply curve shifts to the left in the short run. In the short​ run, aggregate demand decreases. In the short​ run, the aggregate demand curve shifts to the left. Falling output and rising unemployment are accompanied by falling prices in the short run.

The aggregate supply curve shifts to the left in the short run.

Convergence

The process by which poorer countries close the gap with richer countries in terms of real GDP per capita.

inside lags

The time it takes to formulate a policy.

Panel B shows that an increase in taxes shifts the aggregate demand curve to the left, from AD0 to AD1, restoring the economy to full employment.

This is an example of contractionary policy.

Panel A shows that an increase in government spending shifts the aggregate demand curve from AD0to AD1, restoring the economy to full employment.

This is an example of expansionary policy.

If wages are slow to adjust

This is the Keynesian model and refers to a short run period in which G and AD rise, P and GDP rise; wages are unchanged so as P rises real wages fall so firms hire more workers—more workers means more output so GDP rises as P rises (move along AS)

Here is one unusual fiscal​ policy: The government would issue​ time-dated debit cards to each person that had to be spent on goods and services produced only by U.S. firms within a fixed period​ (say, three​ months) or become worthless. Suppose the government was considering whether to issue​ $400 in​ time-dated debit cards to each household or give each household​ $400 in cash instead. Which of the following statements regarding the two plans is​ true? A. Cash payments would have greater immediate impact on spending since they could be spent or invested and the higher the value of the​ MPC, the greater the initial spending as well as the total impact on spending and income. B. ​Time-dated debit cards would have greater immediate impact on consumption spending since they had to be spent within a specific period of time and the higher the value of the​ MPC, the greater the total impact on spending and income. C. Both programs would have the same impact on spending since they made payments of equal size and the value of the MPC would have no impact on spending. D. Cash payments would have greater impact on immediate and total spending but the lower the value of the​ MPC, the larger the impact on immediate consumption spending.

Time-dated debit cards would have greater immediate impact on consumption spending since they had to be spent within a specific period of time and the higher the value of the​ MPC, the greater the total impact on spending and income.

financial derivatives

Tools for dealing with asset risk

R E A L - N O M I N A L P R I N C I P L E

What matters to people is the real value of money or income—its purchasing power—not the face value of money or income.

Some economists are concerned about the​ "brain drain," the phenomenon in which highly educated workers leave developing countries to work in developed countries. Other economists have argued that​ "brain drain" could create incentives for others in the country to secure increased education and many of the newly educated might not emigrate. Explain why the​ "brain drain" could lead to increased education among the remaining residents.

When highly educated workers​ leave, more high paying jobs become available.

Economic growth seems to be affecting the income distribution

While gaps between levels of income between workers with different levels or types of education have long existed, the gap between those levels has been widening in recent decades and that widening seems related to GDP growth.

Interest rate effect

With a given supply of money in the economy, a lower price level will lead to lower interest rates.With lower interest rates, both consumers and firms will find it cheaper to borrow money to make purchases. As a consequence, the demand for goods in the economy (consumer durables purchased by households and investment goods purchased by firms) will increase.

growth accounting equation

Y= F(K,L,A)

Efficient Markets Hypothesis:

You can't do better than using the market valuation of stocks and bonds You can't beat the stock/bond market (on average) Motivated self-interest will self-regulate the stock and bond markets, or at any rate do as well as any regulatory authority would do

And of course that implies that borrowers can get loans from

a bank, from a direct loan from a household, by selling bonds, or by selling stocks

Shifts in SRAS result from ...

a change in the minimum price a firm must charge in order to cover its costs.

Go to the Web site for the Congressional Budget Office​ (www.cbo.gov) and find their 10 year projections for debt as a fraction of GDP.​ See, for​ example, https://www.cbo.gov/publication/49892. As of​ 2015, the​ ten-year projections just show

a slight increase in this measure

President Trump is concerned that Monetary Policy is contributing to these problems. We'll talk about Monetary Policy after the second midterm, but for now please accept that US monetary policy-makers have some influence in affecting the cost of bank loans (interest rate). Use arbitrage theory to explain how an increase in the interest rate charged by U.S. banks would affect each of the following

a. (1 point) Stock prices and their returns. Explain.½ point: Demand for stocks will fall as savers prefer the relatively high rate of return earned by leaving savings in the bank, which will cause stock prices to fall½ point: which will cause the return from stocks to rise toward the bank rate (cheaper stock implies higher return—it is good to "buy low and sell high" later on when stock prices rise again. b. (1 point) Secondary bond prices and their returns. Explain.½ point: Demand for old bonds will fall as the coupon and repayment price on the bonds isn't as attractive as it used to be now that interest rates are higher. This causes secondary bond market prices to fall½ point: which will cause the return from old bonds traded on that market to rise toward the bank rate

Which of the following may influence technological​ progress? A. Research and development spending. B. Monopolies. C. The scale of the market. D. All of the above.

all of the above

Financial intermediaries link households to financial markets, where they

allocate savings to other households, to firms, and to governments.

Arthur Okun distinguished between ________prices, which changed​ rapidly, and ________ ​prices, which are slow to change.

auction custom

According to the accelerator​ theory, a firm anticipating high GDP growth would expect new investment in plant and equipment to

be​ profitable, so they increase investment spending.

Arbitrage between bond markets and bank loans causes

bond prices to rise as interest rates fall.

Financial crises were large (but not sole) contributors to

both the Great Depression and the Great Recession

Arbitrage between stocks and bank loans results in,

ceteris paribus, a negative relationship between stock prices and interest rates.

In poor​ countries, the relative prices for nontraded goods​ (such as household​ services) to traded goods​ (such as​ jewelry) are __________ than in rich countries.

cheaper

The Nobel Prize in Economics went to two economists studying different aspects of "_______" and its impact on economic growth

climate

Education can contribute to economic growth by

complementing physical capital and developing new ideas.

Neo-Keynesians believe mostrecessions are caused by

coordination failures. These coordination failures result in nominal wages being "sticky" or slow to adjust to equilibrium

Risk varies across

countries as it does across firms within countries

Some economists say that economic growth involves a​ trade-off between current generations and future generations. If a current generation raises its saving​ rate, what does it​ sacrifice?

current consumption

"Sovereign" debt (4)

debt issued by a government, rather than by a firm. Generally bond debt There is no collateral; the government can't legally be forced to sell the country's assets in order to pay off the debt so long as the government remains sovereign. Sovereign debt valuation depends on expectations of future tax revenue (related to aggregate productivity forecast, but also to popular willingness to accept tax increases)

As real interest rates rise​, investment spending in the economy will

decrease

If everything else is held​ equal, an increase in the size of the population will increase total output and ▼ increase decrease per capita output.

decrease

To decrease aggregate​ demand, a government can either ▼ increase decrease spending or ▼ increase decrease taxes.

decrease increase

Entitlements- Within the decade the social security system will either

default on its promised obligations to seniors, have to increase its revenue stream through a tax increase, or some combination of the two

A big part of U.S. spending on research and development is in

defense-related areas.

A budget ▼ deficit surplus is the amount by which government spending exceeds revenues in a given year. A budget ▼ surplus deficit is the amount by which government revenues exceed government expenditures in a given year.

deficit surplus

In the short​ run, when prices are slow to adjust to changes in demand and​ supply, ▼ demand government regulation price determines production.

demand

In the short​ run, when prices are slow to adjust to changes in demand and​ supply, ________ determines production.

demand

Which of the following is not a component of aggregate​ demand?

depreciation

From 1966 to​ 1969, there was a 10 percent surcharge that

did not decrease consumer spending as much as economists had initially estimated.

Annual government spending not stipulated by existing laws is called

discrentory

Financial intermediaries reduce the risk of assets​ through:

diversification

Softening demand for Treasurys has also limited the

dollar's gains, analysts say, confounding those who expected the higher yields to make dollar assets more attractive to income-seeking investors.

In recent​ years, many large organizations—such as global accounting firms—have been structured as partnerships for tax purposes rather than corporations. This meant that they did not have to pay the corporate tax. The growth of partnerships as a form of business organization can explain some of the

drop in corporate tax revenue that has occured

deposit rate

earned by savers

liquid

easily convertible into money on a short notice

A highly liquid investment is

easily convertible into money on short notice.

Current U.S. income taxes are not high by

either historical or international standards

During a​ recession, policymakers should

either increase government spending or cut taxes.

The wages of which of the following groups will not adjust​ quickly?

employees of state and local governmentsemployees of state and local governments

In the "balanced growth" model, technological progress ....

equally affects the productivity of both capital and labor (in the aggregate).

Keynesian economics: Prices and output get out of _____________ and output determined by a movement.....

equilibrium away from the full employment level of GDP

Keynesian economics: Wages get out of ____________ and employment is determined by a movement.....

equilibrium Labor Demand away from full employment

Robert Barro(Harvard University)

estimated that the combined effects of the ARRA tax cuts and ARRA spending increases resulted in a multiplier of 80 cents for every dollar of debt accumulated, with a negative long-run multiplier implied by tax increases needed to pay off interest on government borrowing

Christina Romer(UC Berkeley and then-time Chair of President Obama's Council of Economic Advisors or "CEA")

examined US historical data and had as Chair of the CEA predicted a fiscal spending multiplier from the ARRA of up to 2.5 (every $1 spent would lead to a $2.50 increase in GDP). Her ex-post scholarly review of the effectiveness of the ARRA estimated a multiplier of 1.6.

John Taylor (Stanford University)

examined the effect of the tax cuts implemented in the ARRA. As with many previous studies on the effects of temporary tax cuts, he found that the tax cuts were essentially saved and had very little if any impact on the economy. (every $1 tax cut had no impact on AD)

From 2001 until​ 2008,

expansionary policies were used to stimulate the economy.

Fiscal policy that has the intention of increasing aggregate demand is known as being

expansionary.

The stock market values the stock given its

expectations about the firm's future value (profits, inflation, productivity)

Nominal returns compensate for

expected risk

Borrowing has fallen over the last four years, as the economy has been stronger. A stronger economy reduces

expenditures and also increases revenue collection. Government borrowing is always counter-cyclical (moves opposite to GDP) in this way.

Supply shocks are

external events that shift the aggregate supply curve.

Clear property rights reduce growth in an economy because producers are not able to freely use innovations.

false

Corporate taxes are the largest component of federal revenue.

false

Economist William Easterly is a strong proponent of foreign aid.

false

Investment in human capital includes the purchases of computers used by professors.

false

Entitlments-- The Affordable Care Act (aka ObamaCare) is expected to be

federal budget-neutral or better, but possibly to negatively impact state budgets in the medium run

Federal​ spending, spending by the U.S.​ government, consists of two broad​ components:

federal government purchases of goods and services and transfer payments.

Relying on the website for the Federal Reserve Bank of St. Louis ​(www.research.stlouisfed.org/fred2), investment in residential housing over the​ 1990-1991 recession and the period from 2006 to 2011 is shown below. Year Investment in Residential Housing ​(billions $) 1990 224.0 1991 205.1 2006 761.9 2007 628.6 2008 472.5 2009 354.1 2010 340.6 2011 338.7 From the​ data, we can see that for both recessions comma investment in residential housingfor both recessions, investment in residential housing ▼ rose slightly fell .

fell

Under perfect competition, the spread between the lending rate (paid by borrowers)and the deposit rate (earned by savers) equals the costs of

financial intermediation,

Both the Great Depression and the Great Recession were characterized by

financial market crises

Investment spending is financed through

financial markets, which are also quite volatile.

If wages are​ sticky,

firms' product prices will be sticky and reduce the​ economy's ability to bring demand and supply into balance in the short run.

Most neo-Keynesian and neo-classical economists agree that there is a role for

fiscal policy to mitigate financial crises, though they disagree on parts of that role

The Lorenz curve shows inequality has

gotten worse, suggesting stronger incentives to overcome inequality •Is this a short-run problem until everyone accepts higher levels of education? •Is this a long-term problem because the poor don't have equal opportunities and access to education?

Aggregate demand will increase when

government spending increases because government spending is a component of aggregate demand.

If everything else is held​ equal, an increasean increase in the size of the population will ▼ increase decrease total output

increase

If interest rates decrease​, the present value of a fixed payment in the future will

increase

The present value of lottery winnings paid over a​ 20-year period will _________ with a decrease in interest rates.

increase

If everything else is held​ equal, an increase in the size of the population will _______total output and ________ per capita output.

increase decrease

To increaseincrease aggregate​ demand, a government can either ________ spending or ________ taxes.

increase decrease

Suppose a country imposed heavy taxes to increase the price of gasoline. This would affect the incentive to develop battery powered automobiles because as gasoline has become more​ expensive, the payoff for developing a good battery powered car

increases and we should see more inventions.

n the long run, the level of output, yp, is ....

independent of the price level.

The idea that innovations come about through inventive activity designed specifically to reduce costs is known as

induced innovation.

Financial markets are

international. Money flows across borders to find the highest expected return

With a short-run aggregate supply curve, shifts in aggregate demand lead to

large changes in output but small changes in price.

The total shift from a to c will be _______. The ratio of the total shift to the initial shift is known as the ____________.

larger multiplier

Income taxes are the

largest source of government revenue

A contractionary fiscal policy shifts the aggregate demand curve to the _____, _____ prices, and ____ real GDP.

left lowers decreases

Suppose gasoline prices increased sharply and consumers became fearful of owning too many expensive cars. As a​ consequence, they cut back on their purchases of new cars and decided to increase their savings. Assuming a​ short-run aggregate supply​ curve, this behavior shifts the aggregate demand curve to the

left, leading to a large decrease in output and a small decrease in price.

The present value of some future payment indicates the

minimum amount a person is willing to accept today instead of the future payment.

Under U.S.​ law, it is not legal for firms to export crude oil from domestic wells. Assuming the U.S. has now developed a large oil producing​ industry, removing the export restriction will lead to

more exports and higher aggregate demand.

Some economists say that economic growth involves a​ trade-off between current generations and future generations. If a current generation raises its saving​ rate, what will be gained for future generations?

more output and capital

Suppose you are trying to decide whether to take a summer job at​ Clark's Camera Store that pays ​$20 an​ hour, or work for your uncle as his graphic assistant for ​$15 an hour. At​ Clark's Camera Store you would have to pay both income and social insurance taxes on your​ earnings, but if you work for your​ uncle, he will pay you in cash so you can avoid the tax. You will prefer to work for your uncle if the income and social insurance tax rate is

more than 25%

In equilibrium mpk= r, but

mpk is an expected future return

Modern theories of growth that try to explain the origins of technological progress are known as

new growth theories

In larger markets, firms have more incentives to come up with

new products and new methods of production. The lure of profits guides the activities of firms, and larger markets provide firms the opportunity to make larger profits. •This supplies another rationale for free trade. With free trade, markets are larger, and there is more incentive to engage in technological progress.

in​ 2000, the Chinese government mandated three​ one-week holidays throughout the year to stimulate consumer spending. The idea was that these extended vacations would induce the Chinese to spend more of their earnings while on vacation. Although consumption spending rose during the vacation​ period, the data show that consumption fell before and after the vacation by approximately the same amount as spending rose during the vacation. As a​ result, there was _______ change in aggregate demand and the overall policy of stimulating the economy through mandated vacations was ____ effective.

no not

In​ 1999, the Internal Revenue Service began to mail out refund checks because of changes in the tax law in 1998. Assuming that taxpayers were not aware that they\receive refunds until they completed their income tax statements​, the result of the refund would be ▼ no change a decrease an increase in consumption expenditure.

no change

Openness in the trade account is balanced by

openness in financial markets: the ability to borrow from foreigners can lead to capital investments that increase GDP growth

Progressive taxation, safety nets, and the skewed income distribution, result that

over 50% of all income tax collection comes from the top 2% of US wage-earners

Ownership of firm stock is riskier than

ownership of a bond issued by the same firm and stocks therefore yield higher nominal equilibrium returns than do bonds

lending rate

paid by borrowers

Financial intermediaries are considered

part of the infrastructure of a modern economy

Medicare eligibility requires a

payroll tax history that helped support the system, but Medicare is not "off budget" the way Social Security is and it is heavily supported by income tax collection.

Every other country in the OECD has guaranteed health care provided by the government for all of its citizens. In spite of that, the US government ...

pays more per person than nearly any other OECD country even though the government pays for only a small subset of the population and, relative to Western Europe, pays for only a small subset of the medical needs of that subset. The reason is that medical costs are higher here. They are higher because we differ in our regulation of both health care and health insurance. There are both pro's and con's to this but one con is that it is an expensive approach.

​Long-run average income is known as

permanent income

As the population ages and entitlement spending on Social Security and Medicare​ increase, some have argued that we should just raise taxes to pay for them. The main argument against this solution is that the level of entitlements as a fraction of GDP is predicted to

rise so high that raising taxes would dramatically increase the tax burden on the economy and impede economic growth.

HOW FINANCIAL INTERMEDIARIES FACILITATE INVESTMENT: financial intermediaries

savers make deposits to financial intermediaries that make loans to investors

HOW FINANCIAL INTERMEDIARIES FACILITATE INVESTMENT: savers and investors

savers who face risk, loss of liquidity, and costs of negotiation demand high interest rates from investors

▼ Government spending Consumption Saving and ▼ depreciation wage rates capital per worker are the two factors that determine how the stock of capital changes over time.

saving depreciation

Coastal Federal Bank owns numerous mortgages. It packages the mortgages into a portfolio which it sells to investors. They have engaged in

securitization.

If U.S. federal government spending is higher than​ revenue, resulting in a​ deficit, how could it cover the​ shortfall?

sell government bonds

The government borrows by

selling bonds, which it has to pay back with interest in the future.

Investment rises

sharply during booms and falls sharply during recessions.

the bigger MPC, the bigger

shift in AD

During​ recessions, state governments often will have to raise taxes and cut spending in order to keep their own budgets balanced. If a large number of states do​ this, at the national​ level, the aggregate demand curve will

shift to the left since both of these actions are contractionary.

The _______-run aggregate supply curve is a relatively ______ aggregate supply curve that represents the idea that prices do not change very much in the _____ run and that firms adjust production to meet demand.

short flat short

The ▼ short long run in macroeconomics is the period in which prices do not change or do not change very much. In the macroeconomic ▼ short long ​run, both formal and informal contracts between firms mean that changes in demand will be reflected primarily in changes in ▼ prices output ​, not ▼ output prices

short short output prices

Under a parliamentary system like in​ Britain, there are fewer checks and balances on the government than in the United States. In a parliamentary​ system, the party that controls the legislature also runs the executive branch. Consider the inside lag for fiscal policy in England compared to that in the United States. The inside lag would be

shorter in England since it would be easier to reach a consensus on policy changes.

Because of other economic​ factors, such as​ taxes, the multiplier in the United States is ▼ smaller than larger than equal to 2.50.

smaller than

Which of the following is an entitlement​ program?

social security spending

Entitlements:This spending is dominated by

social security, which is a self-funded entitlement program.

The dollar's share of global foreign-exchange reserves fell to 62.5% in the second quarter, its lowest level in five years, data from the International Monetary Fund showed. Goldman Sachs estimates that Russia's central bank alone may have

sold as much as $85 billion in dollar-denominated assets, a move that may have been prompted by concerns over U.S. sanctions.

Household and corporate savings is being leant to the government rather than to private firms and households, so there is at least

some crowding out in the market for loans. There is also the question about US federal willingness to repay its debts, evidenced by government shutdowns and budgetary gridlock, which may eventually affect the willingness of savers to buy US government bonds unless it offers a higher interest rate.

The CBO includes

some data on the behavior of both private sector borrowing (household savings - I, in dark brown) and government savings (tan). Note that private sector balances rose during the years of the Great Recession, reflecting greater austerity (less I and less C, as household savings rose) even though the government was trying to stimulate both C and I through tax cuts and spending increases. These data relate to what economists call the "fiscal multiplier" (fiscal policy affects other sectors of the economy in different ways than do other shocks because of crowding out and because of future tax implications)

(Neo) classical models of the business cycle focus on the latter two types of supply shocks as ----- --- --- --------. In their models input prices only respond to changes in .....

sources of economic fluctuations technology, taxes, subsidies, and government regulations.

Entitlement expenditures are the problem on the _______ side. For social security, we have lots of ...

spending recipients living collecting monthly benefits for longer than had been expected when the promises were first made.

KEYNESIAN STABILIZATION POLICY DURING THE GREAT RECESSION

spent most on tax relief putting america to work with infrastructure building

Unlike the U.S. federal​ government, virtually all states have requirements that they either plan for or maintain a balanced budget. If the national economy experiences a​ recession,

state budgets go into deficits as tax revenues decline.

Sticky wages cause _______ ______ and hamper the economy's ability to..... This problem eventually goes away in the _____ _____

sticky prices bring demand and supply into balance "Long Run"

Medicare The elderly pay for this insurance at a

subsidized rate.

John Maynard​ Keynes' theory regarding investment differs from the accelerator theory in that Keynes argued that

swings in optimism and pessimism are often irrational.

Which of the following factors led the United States from federal surpluses at the end of the 1990s to deficits in the first decade of​ 2000?

tax cuts combined with increase spending

Robert Solow added ________ _______ to the conventional production function to account for technological change.

technologcical progress

Once we account for changes in the labor​ force, -------- is the next biggest source of the growth of GDP in the United States.

technological progress

Once we account for changes in the labor​ force, ____________ ________ is the next biggest source of the growth of GDP in the United States.

technological progress

Robert Solow added ------ ----- to the conventional production function to account for technological change.

technological progress

If the government or large firms employ workers and scientists to advance the frontiers of knowledge in basic​ sciences, their work can lead to

technological progress in the long run.

Because of other economic​ factors, such as​ taxes, the multiplier in the United States is _______ ____ 2.50.

than

WHY IS INVESTMENT SPENDING SO VOLATILE? Accelerator theory argues

that the "animal spirits" are not random, but are instead over-reactions to real changes in productivity, so that AD follows LRAS but tends to over-shoot.

Convergence is the process by which poorer countries close the gap with richer countries in terms of real GDP per capita. Suppose the line in the figure at right pointed up and and to the right. That would tell us

that there is less of a tendency for convergence---> The​ downward-sloping line plotted through the points indicates that the countries with higher levels of per capita income in 1870 grew more slowly than countries with lower levels. In other​ words, the tendency was for countries with lower levels of initial income to grow faster and catch up. An upward minus slopingAn upward−sloping line would imply that countries with lower levels of initial income grow slowerslower and cannot catch​ up, so there is less tendency for convergence.

Convergence is the process by which poorer countries close the gap with richer countries in terms of real GDP per capita. Suppose the line in the figure at right was horizontal. That would tell us

that there is less of a tendency for convergence.

An adverse supply shock, such as an increase in the price of oil, will cause the .... The result will be .....

the AS curve to shift upward higher prices and a lower level of output.

A movement along the SRAS curve is a movement along....

the Labor Demand curve.

Jeremy Lawson, head of the Aberdeen Standard Investments Research Institute, which manages $730 billion, said his fixed income team is betting that Treasury prices will decline, as

the U.S. government issues more bonds while the Fed decreases its pace of bond buying.Despite higher yields, "most investors still aren't getting paid enough to hold U.S. government bonds for the long term," Mr. Lawson said.

In professional​ football, salaries are determined by the league for the first several​ years, but then the athletes have a chance to become free agents and seek employment with other teams. When they are under​ contract, the athletes have

the athletes have sticky wages but they become flexible when they become free agents.

Secondary bond market prices reflect the market's assessment of

the bond's risk

Here is one unusual fiscal​ policy: The government would issue​ time-dated debit cards to each person that had to be spent on goods and services produced only by U.S. firms within a fixed period​ (say, three​ months) or become worthless. Suppose the government was considering whether to issue​ $400 in​ time-dated debit cards to each household or give each household​ $400 in cash instead. As far as the administration of the two programs is​ concerned,

the cash payments program is easier to administer through a tax rebate program.

Here is one unusual fiscal​ policy: The government would issue​ time-dated debit cards to each person that had to be spent on goods and services produced only by U.S. firms within a fixed period​ (say, three​ months) or become worthless. Suppose the government was considering whether to issue​ $400 in​ time-dated debit cards to each household or give each household​ $400 in cash instead. Suppose a family had large credit card​ debt, which it wished to reduce. Of the two​ plans, the family would prefer

the cash payments​ program, since cash could be used to pay off some of the credit card debt.

A U.S. 10-year note yields about 2.7 percentage points higher than German debt with a similar maturity, an unusually large margin. But investors in the currency market expect the euro to rise against the dollar as the European Central Bank begins raising interest rates next year, making the euro more attractive to yield-seekers.By contrast, many believe the dollar's value largely reflects monetary policy expectations in the U.S.: The Federal Reserve has raised rates eight times since 2015, and policy makers have penciled in four more increases by the end of 2019.As a result, hedging dollars is expensive: Foreign investors must pay 3% on an annualized basis to hedge against fluctuations of the dollar, making the trade unprofitable for many.

the euro to rise against the dollar as the European Central Bank begins raising interest rates next year, making the euro more attractive to yield-seekers.

creative destruction

the view that a firm will try to come up with new products and more efficient ways to produce products to earn monopoly profits.

Stocks and Bonds are both risky because

their current value depends on expectations about the future.

In the Great​ Depression, during the​ 1930s,

there was no net fiscal expansion.

What was unique about the tax cuts proposed and enacted during Ronald​ Reagan's presidency in​ 1981?

they were justified on the basis of increasing economic incentives.

An increase in aggregate demand leads ....

to a higher price level.

Growth rates should be higher in lower-income countries if they are

to converge with richer economies

The Congressional Budget Office​ (CBO) makes​ long-run budget deficit projections. Although these projections are based on restrictive and often unrealistic​ assumptions, the CBO makes these projections

to help guide fiscal policy

The aggregate demand curve plots the

total demand for real GDP as a function of the price level.

In an economy with no government sector or foreign​ sector, saving must equal investment because

total income is equal to consumption and saving. total demand is equal to consumption and investment. total income is equal to total demand.

The United States spends more .....

total money than any other country on research and development. However, when the spending is measured as a percentage of each nation's GDP, Japan spends more.

A higher saving rate will lead to a higher stock of capital in the long run

true

Economists who have studied economic growth find only weak evidence for convergence among countries between 1980 and 2000.

true

Free trade leads to more research and development because it promotes larger markets.

true

If a country runs a trade deficitdeficit to finance increased current​ consumption, it will have to reducereduce consumption in the future to pay back its borrowings.

true

Many economists believe countries that open themselves to foreign investment of plant and equipment will benefit in terms of increased technological change because local companies will learn from the foreign companies. In the last several​ decades, China has been more open to foreign investment than India.

​China's growth in GDP was much higher than​ India's growth in GDP.

What else can go wrong?• Governments in developing countries often:

•Adopt policies that effectively tax exports •Pursue policies that lead to rampant inflation •Enforce laws that inhibit the growth of the banking and financial sectors