Econ 4353 Exam 1

Real GDP formula

=Nominal GDP/GDP Deflator = sum of (Base year price x Current year quantity)

Nominal GDP formula

=Real GDP x GDP Deflator = sum of (quantity of good X cost of good)

supply curve

A curve that shows the relationship between quantity supplied and price, holding everything else constant

inflation rate

A measure of how fast the general level of prices is rising

Consumer Price Index (CPI)

A measure of the overall level of prices Uses: 1. Track changes in the typical household cost of living 2. Allow comparison of dollar amounts over time

deflation

A period of falling prices

The loanable funds market

A simple supply-demand model of the financial system

exogenous variable

A variable determined outside the model; the model takes their values and behaviors as given. value is independent of the models solution

Market Clearing

An assumption that prices are flexible and adjust to equate supply and demand.

Economic models are used to show how ______ variables affect the ______ variables

Exogenous ; endogenous

Factors of production

Factors of production are the inputs used to produce goods and services - K = capital - L = Labor

Real GDP

GDP adjusted for inflation - constant base year prices

Nominal GDP

GDP measured in current prices

demand curve

shows the relationship between quantity demanded and price, other things equal.

Economic models are

simplified versions of more complex realities with irrelevant details stripped away

in the short-run prices are ____

sticky

T =

taxes - transfer payments

Marginal propensity to consume (MSC)

the change in consumption(C) when disposable income increases by one dollar

Unit of account

the common unit by which everyone measures prices and values

D ( )

the function linking the variables

monetary policy definition

the government control over the money supply

Private savings

the income that households have left after paying for taxes and consumption = (income - taxes) - consumption = Disposable income - Consumption

In the classical model with fixed output, the supply and demand for goods and services are balanced by

the interest rate

GDP (formal definition)

the market value of all final goods and services produced

The funds in a checking account serve which three functions of money

all 3

Medium of exchange

anything that is used to determine value during the exchange of goods and services. - we use it to buy stuff

A price increase of an input variable causes the supply/supply curve

causes supply to decrease; supply curve shifts left - decrease in quantity and increase in price

A price decrease of an input variable causes the supply/supply curve

causes supply to increase; supply curve shifts right - increase in quantity and decrease in price

decrease in aggregate income causes the demand/demand curve

causes the demand to decrease; demand curve shifts left - decreases price and quantity of good

increase in aggregate income causes the demand/demand curve

causes the demand to increase; demand curve shifts right - increases price and quantity of good

A decrease in national saving, perhaps resulting from an increase in government purchases or a decrease in taxes, ______ the supply of loanable funds, _____ the equilibrium amount of investment, and _____ the interest rate

decreases; reduces; raises

the investment function slopes _____ because as the interest rate rises, the quantity of investment demand ____

downward; falls

The investment function slopes _____ because there are _____ investment projects that are profitable as the interest rate decreases

downward; more

Real gross domestic product (GDP) _____ over time, and the growth rate of real GDP _____.

grows; fluctuates

In the classical model with fixed income, if the interest rate is too low, then investment is too _____, and the demand for output _____ the supply.

high; exceeds

Economists can calculate the U.S. unemployment rate by using ______ survey but not the _____ survey

household survey but not the establishment survey

Government spending (G)

includes spending by all levels of government goods and services - ex. defense, highways, serves provided by government workers

disposable income

income (after taxes) that is available to you for saving or spending - (Y - T)

Real gross domestic product (GDP) is a better measure of economic well-being than nominal GDP because real GDP:

measures changes in the quantity of goods and services produced by holding prices constant.

Money supply (M) definition

the quantity of money available in the economy

Which variable adjusts to bring the market for goods and services into equilibrium

the real interest rate (r)

supply of funds

the supply of loanable funds from savings(S) - private and public

public saving

the tax revenue that the government has left after paying for its spending = (taxes net of transfers) - Government spending

Consumption (C)

the value of all goods and services bought by households - 2/3 of GDP (largest) - durable goods (cars) - nondurable goods (food) - services- largest (travel, healthcare)

An economy's _____ equals its _____

total income; total expenditure on goods and services

In equilibrium, total investment equals

national savings

real interest rate (r)

nominal interest rate corrected for inflation - the cost of borrowing

Crowding out

occurs when a government deficit drives up the interest rate and leads to reduced investment spending

National Savings =

private saving + public saving

money

Is the stock of assets that can readily be used to make transactions

A decrease in investment demand. Causes I1 to shift ___ to I2. Does the S,I move? R ____

- Causes I1 to shift left to I2 (along the vertical S curve) - S,I is fixed; stays the same - r decreases

How the CPI is constructed by the BLS

- Monthly consumer surveys: identifies the "basket: of commonly purchased goods and services - Monthly Price Data Collection: gathers current price information for all items in the consumer basket

Sticky prices

- adjust sluggishly in response to changes in supply or demand. -ex. price of soda in vending machine

personal consumption expenditures deflator (PCE)

- another measure of the price level - ratio of nominal to real consumer spending - Fed uses PCE for inflation targeting

An increase in investment demand

- cause I1 to shift right to I2 (along the vertical S curve) - S,I is fixed; stays the same - r increases

Causes for decrease in budget deficit

- decrease in government spending - increase in taxes

Total output is determined by:

- economy's quantities of capital and labor - level of technology

Causes for increase in budget deficit

- increase in government spending - tax cuts (taxes decrease)

A decrease in demand for investment goods (taxes do not changes) causes the equilibrium combination of real interest rate, saving, and investment:

- investment( demand curve) shifts to the left along the vertical S(supply) curve the S curve does not change - real interest rate decreases

An increasing in r does what to savings and consumption?

- makes saving more attractive; which increases the reward for postponing consumption. - savings increase and consumption decreases.

production function

- mathematical relationship between factors of production and the quantity of output produced. - shows how much output(Y) the economy can produce from K units of capital and L units of labor. - reflects the economy's level of technology

Crowding out and what it does to saving, investment and equilibrium

- r increases - savings and investment decrease - only S shifts from s1 to s2 (along the fixed D curve) ; D1 stays the same

Loanable funds supply curve

- vertical - not depend on the real interest rate (r)

The MSC is between

0 and 1

Problems with CPI (why the CPI may overstate inflation)

1. Substitution bias - Fixed weights in CPI don't capture consumer shift to cheaper goods 2. Introduction of new goods - The introduction of new goods makes consumers better off - But not reflected in CPI 3. Unmeasured changes in quantity - Quality in prices increases the value of the dollar

3 equivalent GDP measures:

1. Total output 2. Total income 3. Total expenditure

GDP does not include

1. intermediate goods 2. uses good

Factors that shift the investment curve

1. technological inovations 2. tax laws that affect investment (investment tax credit)

Investment function

I = I(r) - Investment decrease with the real interest rate

flexible prices

Prices that adjust quickly to equilibrate supply and demand - ex. price of gas at a gas station

Demand Equation

Qd = D(P,Y). Shows that the quantity consumers demand is related to the price and aggregate income

supply equation

Qs = S(P,Ps)

An increase in taxes does what to real interest rate, saving, and investment

Savings and investment: increase ; vertical S(supply curve) shifts to the right along I(demand curve) Real interest rate: decrease

Investment (I)

Spending on capital, a physical asset used in future production (goods bought for future use). NOT financial investment - 1/6 of GDP - business fixed investment - largest component (spending on plant and equipment) - residential fixed investment (buying a house) - inventory investment (change in the value of all firms inventories)

Government budget deficit

T < G - public saving < 0

Government budget balance

T = G - public savings = 0

government budget surplus

T > G - public saving > 0

Macroeconomics

The study of the economy as a whole

gross domestic product (GDP)

The total income of everyone in the economy adjusted for the level of base year prices

Loanable fund (S,I) is on the ___ axis

X

Interest rate is on the ___ axis

Y

decreasing returns to scale

a + b < 1

constant returns to scale

a + b = 1

increasing returns to scale

a + b > 1

endogenous variable

a variable that is determined within the model. value is determined by the models solution.

A consumption function shows the relationship between _____ and ______

consumption and disposable income

In the classical model with fixed income, if the demand for goods and services is less than the supply, the interest rate will:

decrease

Net Exports (NX)

exports - imports - net spending from abroad on our goods and services

In the long run, the level of national income in an economy is determined by its ______ and ______

factors of production and production function

If interest rates rise, financing is more expensive, and the quantity of investment goods demand _____

falls

In the classical model with fixed income, if households and the government want to save more than firms want to invest, then the real interest rate _____

falls

To avoid double counting in the computation of gross domestic product (GDP), GDP includes only the value of _____ goods.

final

in the long run prices are ___

flexible and can respond to changes in supply or demand.

An increase in investment demand, perhaps because of a technological innovation or a tax incentive for investment,_____ the demand for loanable funds and _____ the interest rate.

increases; raises

demand for funds

investment (I) - depends negatively on r

How does the government finance its budget deficit

issuing treasury bonds - borrowing money

NX < 0

trade deficit

NX > 0

trade surplus

Government spending excludes...

transfer payments - ex/. Unemployment insurance payments because they do not represent spending on goods and services

Store of value

transfers purchasing power from the present to future