ECON FINAL EXAM STUDY GUIDE

unemployment rate

# of unemployed/labor force x100

If the reserve requirement is 10%, a withdrawal of $500 leads to a potential decrease in the money supply of:

$5,000.

Sumit deposits $1,500 cash into his checking account. The reserve requirement is 25%. How much money can the banking system create?

$6,000

income per capita =

(GDP/population)=(GDP/employment)x(employment/population)

inelastic demand

(remember bc D curve stands up like an "I") percentage change in quantity demanded is less than the percentage change in price-- the absolute value of the price elasticity is less than 1 inelastic goods are not responsive to changes in price

perfect elastic demand

(remember bc the graph looks like an "E" for elastic)

open market operations explanation

- Fed buys and sells government bonds on the open market - Fed buys bonds (basically creates money out of nothing)-> supply of reserves increases-> FFR decreases - Fed sells bonds-> supply of reserves decreases-> FFR increases

how does the Fed's buying and selling of bonds affect the economy?

- enables banks to make more loans - other interest rates in the economy tend to follow the FFR

ways to increase productivity

- increasing access to natural resources - increasing quality of labor (human capital) -increasing capital-to-labor ratio -promoting innovation and technology

monopolistic competition

- many buyers and sellers - differentiated products - little/no barriers to market entry/exit -no long run economic profit -some control over price (limited market power)

perfect competition characteristics

- many buyers and sellers - homogenous products - no barriers to market entry or exit - no long-run economic profit - no control over price (no market power)

oligopoly

-fewer firms (auto industry) -mutually interdependent decisions -substancial barriers to market entry -potential for long run economic profit -shared market power and considerable control over price

monopoly

-one firm -no close product substitutes -nearly insuperable barriers to entry -potential for long run economic profit -substancial market power and control over price

sources of market power

-significant control over factors of production (barriers to entry) - economies of scale - gov't franchises, patents, and copyrights

MPC+MPS=

1

The slope of the saving schedule is:

1 minus the marginal propensity to consume

steps to profit maximization in general

1. find where MC=MR 2. At the point where MC=MR, find the corresponding point on the horizontal axis, this is the profit-maximizing output 3. At the profit maximizing output, draw a line straight up to the demand curve and then to the vertical axis. This is the profit maximizing price 4. Again using the profit-maximing output, draw a line straight up to the average total cost curve, and then to the vertical axis. This is the ATC per unit 5. Find the profit, which is the rectangle formed between the profit maximizing price and average total cost on the vertical axis, and the profit maximizing output on the horizontal axis (so basically the area between ATC and demand curve is the profit)

how to find profit in perfectly competitive market

1. find where MC=MR 2. drop line from point down to ATC curve 3. Make box with vertical axis-- this is profit (P-ATC)*Q=TP or TR-TQ=TP

Fed's dual mandate

1. full employment 2. low and stable inflation

Fed's two major roles:

1. maintain the payments system in economy and financial stability 2. control the money supply and influence interest rates

three basic economics questions that each society must answer

1. what goods and services are to be produced? 2. how are these goods and services to be produced? 3. who will receive these goods and services?

multiplier equation

1/(1-MPC) or 1/MPS

number of years to double value=

70/growth rate

M2

A broader definition of money that includes "near monies" that are not as liquid as cash, including deposits in savings accounts, money market accounts, and money market mutual fund accounts. money that cannot be drawn on instantaneously but nonetheless accessible

Laffer curve

A curve that shows a hypothetical relationship between income tax rates and tax revenues. At point c, tax revenues are maximized. If tax rates continue to rise, tax revenues will decrease because higher tax rates discourage people from working and firms from producing. A government collects the same tax revenues at points a or b. The tax rates that correspond to points b and c are often debated by economists.

money multiplier

A formula that measures the potential or maximum amount the money supply can increase (or decrease) when a dollar of new deposits enters (exits) the system and is defined as 1 divided by the reserve requirement.

medium of exchange

A function of money in which goods and services are sold for money, then the money is used to purchase other goods and services.

money illusion

A misperception of wealth caused by a focus on increases in nominal income but not increases in prices.

leakages

A reduction in the amount of money that is used for lending that reduces the money multiplier. It is caused by banks choosing to hold excess reserves and from individuals, businesses, and foreigners choosing to hold more cash.

externalities

A side effect of an action that affects a third party other than the buyer or seller.

surplus

A situation in which quantity supplied is greater than quantity demanded

solvency crisis

A situation when a bank's liabilities exceed its assets.

regressive tax

A tax for which the percentage of income paid in taxes decreases as income increases

Expansionary monetary policy shifts the _____ curve to the _____.

AD; right

The 45-degree line in the Keynesian model represents:

AE = Y.

aggregate expenditure equation

AE=C+I

average fixed cost curve

AFC curve always decreases as production increases This is because, in the short run, total fixed costs do not change so that increasing production spreads the fixed costs over more units of output (the spreading effect).

Average Propensity to Consume (APC)

APC=C/Y consumption spending/income

Average Propensity to Save (APS)

APS=S/Y

functional finance

An approach that focuses on fostering economic growth and stable prices, while keeping the economy as close as possible to full employment.

money

Anything that is accepted in exchange for goods and services or for the payment of debt.

cyclically balanced budget

Balancing the budget over the course of the business cycle by restricting spending or raising taxes when the economy is booming and using these surpluses to offset the deficits that occur during recessions.

economies of scope

By producing a number of products that are interdependent, firms are able to produce and market these goods at lower costs.

components of GDP

C+I+G+(X-M)

paradox of thrift

Consumer uncertainty causes people to save more; consumption falls; equilibrium income and production falls; savings decreases because income is lower.

fractional reserve banking system

Describes a banking system in which a portion of bank deposits are held as vault cash or in an account with the regional Federal Reserve Bank, while the rest of the deposits are loaned out to generate the money creation process.

average total cost

Equal to total cost divided by output (TC/Q). Average total cost is also equal to AFC + AVC.

average variable cost

Equal to total variable cost divided by output (VC/Q).

Suppose policymakers wish to use fiscal policy to fight inflation. Which statement, then, is MOST accurate?

Essentially, the way to lower the inflation rate is to decrease aggregate demand, causing a rise in unemployment.

annually balanced budget

Expenditures and taxes would have to be equal each year.

contractionary monetary policy

Fed actions designed to decrease the money supply and raise interest rates to shrink income and employment, usually to fight inflation.

easy money, quantitative easing, or accommodative monetary policy

Fed actions designed to increase excess reserves and the money supply to stimulate the economy (increase income and employment).

expansionary monetary policy

Fed actions designed to increase the money supply and lower interest rates to stimulate the economy (expand income and employment).

The main policymaking arm of the Fed is the:

Federal Open Market Committee

oligopoly

Fewer firms (such as the auto industry) Mutually interdependent decisions Substantial barriers to market entry Potential for long-run economic profit Shared market power and considerable control over price

GDP-PPP

GDP adjusted for cost of living relative to a base country

real GDP

GDP adjusted for inflation-- uses a base year to account for inflation

GDP components

GDP= C(consumption)+I(investments)+G(gov't spending)+(x-m)net exports

public good

Goods that are neither excludable nor rival in consumption. Consumption by one person cannot diminish the benefit to others of consuming the good.

GDP per capita

Gross domestic product divided by the number of people in the population. Used to find the country's standard of living

laissez-faire

Hands off. No government intervention.

supply

How much of a good or service a producer is willing and able to produce at different prices.

liquidity

How quickly, easily, and reliably an asset can be converted into cash.

multiplier

K=1/(1-MPC) or K=1/MPS

monetary rule

Keeps the growth of money stocks such as M1 or M2 on a steady path, following the equation of exchange (or quantity theory), to set a long-run path for the economy that keeps inflation in check.

antitrust laws

Laws designed to promote competition and fairness to prevent monopolies

equation of exchange

M × V = P × Q where V and Q are fixed, thus: change in M=change in P where M is the supply of money, V is the velocity of money (the average number of times per year a dollar is spent on goods and services, or the number of times it turns over in a year), P is the price level, and Q is the economy's real output level.

what is the relationship between marginal revenue and price for a monopoly?

MR<P, because the demand curve is downward sloping Because the monopolist's demand curve is identical to the market demand curve, the monopolist can sell an additional unit of output only by lowering the product's price. Assuming no price discrimination (charging different customers different prices for the same good), this lower price is charged for all units of the commodity sold. As a consequence, the firm's marginal revenue curve lies below its demand curve. Marginal revenue is less than price.

long-run equilibrium for the perfectly competitive firm

Market price in the long run is PLR, corresponding to the minimum point on the SRATC and LRATC curves. At point e, P = MR = MC = SRATCmin = LRATCmin. This is why economists use perfectly competitive markets as the benchmark when comparing the performance of other market structures. With competition, consumers get just what they want because price reflects their desires, and they get these products at the lowest possible price (LRATCmin). Further, as panel A illustrates, the sum of consumer and producer surplus is maximized. Any reduction in output reduces the sum of consumer and producer surplus.

MONETARIST THEORY ON MONEY SUPPLY

Monetarists argue that a change in output will last only for the short run; in the long run, the economy will move back to full employment. The economy begins in equilibrium at point e. An increase in the money supply of 10% shifts the aggregate demand curve from AD0 to AD1, resulting in higher short-run output, $16 trillion, and a higher price level at point b. Over time, the economy will move back to full employment output ($15 trillion), increasing the price level in the long run to 110 (a 10% increase) at point c. The long-run aggregate supply curve is vertical at the full employment output of $15 trillion.

DEMAND SHOCKS, SUPPLY SHOCKS, AND MONETARY POLICY

Monetary policy can be effective in counteracting a demand shock. In panel A, the economy begins in full employment equilibrium at point e and then a demand shock reduces aggregate demand to AD1, resulting in a new equilibrium (point a). Expansionary monetary policy will shift aggregate demand back to AD0, restoring full employment output ($15 trillion) and prices (100). Monetary policy is less effective in counteracting a supply shock. In panel B, a negative supply shock shifts SRAS0 to SRAS1. The new equilibrium (point a) is at a higher price level, 105, and lower output, $14 trillion, a doubly negative result. The Fed could use expansionary monetary policy to shift AD0 to AD1; this would restore the economy to full employment output (point b), but at an even higher price level (110). Alternatively, the Fed could focus on price level stability, using contractionary monetary policy to shift aggregate demand to AD2, but this would further deepen the recession as output falls to $13 trillion (point c).

fiat money

Money without intrinsic value but nonetheless accepted as money because the government has decreed it to be money.

monopoly

One firm No close substitutes for product Nearly insuperable barriers to entry Potential for long-run economic profit Substantial market power and control over price

What occurs during a negative demand shock?

Output and price level decrease.

total product curve, marginal product, and average product

Panel A shows how increasing labor increases productivity, up to a point. Panel B shows marginal and average product. Marginal product reaches its maximum as the third worker is hired, after which marginal product starts decreasing. Total product keeps increasing, however, until you reach 6 employees. At that point, marginal product becomes negative, meaning that each additional employee actually reduces production.

contractionary fiscal policy

Policies that decrease aggregate demand to contract output in an economy. These include reducing government spending, reducing transfer payments, and/or raising taxes.

supply-side fiscal policies

Policies that focus on shifting the long-run aggregate supply curve to the right, expanding the economy without increasing inflationary pressures. Unlike policies to increase aggregate demand, supply-side policies take longer to impact the economy.

expansionary fiscal policy

Policies that increase aggregate demand to expand output in an economy. These include increasing government spending, increasing transfer payments, and/or decreasing taxes.

discretionary fiscal policy

Policies that involve adjusting government spending and tax policies with the express short-run goal of moving the economy toward full employment, expanding economic growth, or controlling inflation.

teaser rates

Promotional low interest rates offered by lenders for a short period of time to attract new customers and to encourage spending.

externally held debt

Public debt held by foreigners, including foreign industries, banks, and governments.

internally held debt

Public debt owned by domestic banks, corporations, mutual funds, pension plans, and individuals.

excess reserves

Reserves held by banks above the legally required amount.

long-run adjustments with short-run economic profits for perfectly competitive firms

Short-run economic profits lead other firms to enter the industry, thus raising industry output to QL in panel A, while forcing prices down to PL. The output for individual firms declines as the industry moves to long-run equilibrium at point b. In the long run, firms in perfectly competitive markets can earn only normal profits, as shown by point b in panel B.

five step process to determine maximum profit

Step 1: Find the point at which marginal revenue (MR) equals marginal cost (MC). Remember that in a perfectly competitive market, MR equals price. Step 2: At the point at which MR = MC, find the corresponding point on the horizontal axis; this is the profit-maximizing output. Step 3: At the profit-maximizing output, draw a line straight up to the demand curve (which is equal to MR in a perfectly competitive market) and then to the vertical axis. This is the profit-maximizing price. Step 4: Again using the profit-maximizing output, draw a line straight up to the average total cost curve, and then to the vertical axis. This is the average total cost per unit. Step 5: Find the profit, which is the rectangle formed between the profit-maximizing price and average total cost on the vertical axis, and the profit-maximizing output on the horizontal axis.

asset that pays a rate roughly equal to the rise in prices (inflation)

TIPS (treasury inflation-protected security) bond

Which statement concerning the structure of the Federal Reserve System is correct?

The Chair and Vice Chair of the Board of Governors are appointed by the president and confirmed by the Senate for terms of 4 years.

surplus

The amount by which annual tax revenues exceed government expenditures.

average total cost, average variable cost, and marginal cost

The bowl shape of the AVC and ATC curves demonstrates the law of diminishing returns: Beyond a certain level of output, average costs increase. Marginal costs represent the added cost of producing one more unit of output. Note that the marginal cost curve passes through the minimum points on both the AVC and ATC curves.

open market operations

The buying and selling of U.S. government securities, such as Treasury bills and bonds, to adjust reserves in the banking system.

marginal cost

The change in total costs arising from the production of additional units of output (ΔTC/ΔQ). Because fixed costs do not change with output, marginal costs are the change in variable costs associated with additional production (ΔVC/ΔQ). MC = ΔTC/ΔQ = ΔFC/ΔQ + ΔVC/ΔQ

barter

The direct exchange of goods and services for other goods and services.

public choice theory

The economic analysis of public and political decision making, looking at issues such as voting, the impact of election incentives on politicians, the influence of special interest groups, and rent-seeking behaviors

THE MULTIPLIER AND GOVERNMENT SPENDING

The economy is initially in equilibrium at point e. As new government spending works its way through the economy round-by-round, both income and output are multiplied, but price increases absorb some of the increase in AD. Once the economy reaches full employment (point a), price increases absorb all of the increase in AD.

compounding effect

The effect of interest added to existing debt or savings leading to substantial growth in debt or savings over the long run.

store of value

The function that enables people to save the money they earn today and use it to buy the goods and services they want tomorrow.

government budget constraint

The government budget is limited by the fact that G − T = ΔM + ΔB + ΔA where G = government spending T = tax revenues; thus, (G − T) is the federal budget deficit ΔM = the change in the money supply (selling bonds to the Federal Reserve) ΔB = the change in bonds held by public entities, domestic and foreign ΔA = the sales of government assets

federal funds rate

The interest rate financial institutions charge each other for overnight loans used as reserves.

discount rate

The interest rate the Federal Reserve charges commercial banks and other depository institutions to borrow reserves from a regional Federal Reserve Bank.

M1

The narrowest definition of money that measures highly liquid instruments including currency (banknotes and coins), demand deposits (checks), and other accounts that have check-writing or debit capabilities. most liquid part of the money supply

tradeoff between risk and return

The pattern of higher risk assets offering higher average annual returns on investment than lower risk assets.

reserve ratio

The percentage of a bank's total deposits that are held in reserves, either as cash in the vault or as deposits at the regional Federal Reserve Bank.

public debt

The portion of the national debt that is held by the public, including individuals, companies, pension funds, along with foreign entities and foreign governments. This debt is also referred to as net debt or federal debt held by the public.

reserve requirement

The required ratio of funds that commercial banks and other depository institutions must hold in reserve against deposits.

recognition lag

The time it takes for policymakers to confirm that the economy is in a recession or a recovery. Short-term variations in key economic indicators are typical and sometimes represent nothing more than randomness in the data.

information lag

The time policymakers must wait for economic data to be collected, processed, and reported. Most macroeconomic data are not available until at least one quarter (three months) after the fact.

implementation lag

The time required to turn fiscal policy into law and eventually have an impact on the economy.

national debt

The total debt issued by the U.S. Treasury, which represents the total accumulation of past deficits less surpluses. A portion of this debt is held by other government agencies, and the rest is held by the public. It is also referred to as the gross federal debt.

FISCAL POLICY AND AGGREGATE SUPPLY

The ultimate goal of fiscal policy directed at aggregate supply is to shift the long-run aggregate supply curve from LRAS0 to LRAS1. This moves the economy's full employment equilibrium from point a to point b, expanding output from Q0 to Q1 while keeping inflation in check. With these fiscal policies, inflationary pressures are reduced as output expands, but these policies take a longer time to have an impact.

long-run average total cost

This figure shows the average total cost curve for three plants of different sizes. The larger plants have relatively high average total costs at lower levels of output, but much lower average total costs at higher output levels. Firms are free to adjust plant size in the long run; therefore, they can switch from one plant type to the next to MINIMIZE their costs at each production level. The green envelope curve represents the firm's lowest cost to produce any given output in the long run and represents the LRATC curve.

THE MARKET FOR LOANABLE FUNDS

This market represents supply and demand for loanable funds. Savers spend less than they earn and supply the excess funds to the market. Borrowers (primarily businesses) have potential profit-making investment opportunities, and this leads to their demand for funds. Equilibrium is at point e. supply curve represents the savers while the demand curve represents the borrowers

The rule of 70

To estimate the number of years for a variable to double, take the number 70 and divide it by the growth rate of the variable.

substitute goods

Two goods are consumer substitutes if they provide essentially the same utility to the consumer-- when the price of one good rises, the demand for the other good increases

complementary goods

Two goods that provide more utility when consumed together than when consumed separately-- when the price of one good rises, the demand for the other one falls PB&J!!!!

Which of the following items is NOT public debt? Treasury notes Treasury bonds U.S. dollars U.S. savings bond

US dollars

expansionary fiscal policy at full employment

When an economy is already at full employment, expansionary policies lead to no long-run improvement in real GDP. Beginning at full employment (point e), increasing aggregate demand moves the economy to output level Q1 above full employment (point a). This higher output is only temporary, however, as workers and suppliers adjust their expectations to the higher price level (P1), thus shifting short-run aggregate supply left toward SRAS2. But this just pushes prices up further, until finally workers adjust their inflationary expectations, and the economy settles into a new long-run equilibrium at point b, where the economy is again at full employment, but at a higher price level (P2).

liquidity trap

When interest rates are so low, people hold on to money rather than invest in bonds due to their expectations of a declining economy or an unforeseen event such as war.

expansionary fiscal policy below full employment

When the economy is below full employment, expansionary policies move it to full employment. Here, the economy begins at equilibrium at point e, below full employment. Expansionary fiscal policy increases aggregate demand from AD0 to AD1, raising equilibrium output to Qf and the price level to P1 (point f).

a perfectly competitive form minimizing losses

When the market price falls below the average total cost of production curve, but remains above average variable cost. In this situation, it is best to keep producing because fixed costs still have to be payed, and without production, losses would amount.

sole proprietorship

a business owned and managed by a single individual who is subject to unlimited liability

deflation

a decline in overall prices throughout the economy.

Simultaneous recession and deflation can be explained by:

a decrease in aggregate demand.

price ceiling

a legal maximum on the price at which a good can be sold. When price ceiling is set below equilibrium, a shortage occurs

price floor

a legal minimum on the price at which a good can be sold. when a price floor is set above equilibrium, a surplus results

perfect competition

a market structure in which a large number of firms all produce the same product no barriers to entry or exit no long-run economic profit no control over price (no market power)

price elasticity of demand (Ed)

a measure of how responsive quantity demanded is to a change in price Ed= (% change in Qd/ % change in P)

income elasticity of demand

a measure of how responsive quantity demanded is to changes in consumer income

cross elasticity of demand

a measure of how responsive the quantity demanded of one good is to changes in the price of another good

GDP deflator

a measure of price inflation/deflation with respect to a specific base year . Unlike the CPI, the GDP deflator is not based on a fixed basket of goods and services; the "basket" for the GDP deflator is allowed to change from year to year with people's consumption and investment patterns.

fiscal sustainability

a measure of the present value of all projected future revenues compared to the present value of projected future spending.

increasing marginal returns

a new worker hired adds more to total output than the previous worker hired, so that both average and marginal products are rising

disinflation

a reduction in the rate of inflation (inflation still present, but is decreasing)

classical economics

a school of thought based on the idea that free markets regulate themselves, and that rising debt is unsustainable and creates and undue burden on future generations that can prevent them from achieving their economic goals

What would cause the price level to decrease and employment to increase?

a shift to the right of the SRAS curve

productive efficiency

a situation in which a good or service is produced at their lowest resource (opportunity) cost

asymmetric information

a situation in which one party to an economic transaction has less information than the other party

shortage

a situation in which quantity demanded is greater than quantity supplied

market failure

a situation in which the market does not distribute resources efficiently and does not provide a socially optimal level of output (usually too high or low of a price)

According to Malthus, a fixed quantity of land and a growing human population will eventually produce:

a stationary state in which growth will cease.

flat tax

a tax system in which all people pay the same percentage of their income

lump-sum tax

a tax that is the same amount for every person-- a type of regressive tax

progressive tax

a tax that rises in percentage of income as income increases

keynesian economics

active role in government is needed to ensure that economic activity is promoted in areas where markets cannot do it alone. Theory that the government must spend money to stimulate the economy during recessions.

_____ is the output of goods and services demanded at different price levels.

aggregate demand

The solution to simultaneous deflation and unemployment is to shift the:

aggregate demand curve to the right.

profit-maximizing rule

all firms maximizing profit by producing where marginal return (MR) = marginal cost(MC). No other level of output produces higher profits.

At equilibrium

all spending injections into the economy equal all withdrawals of spending. I + G + X = S + T + M

diminishing marginal returns

an additional worker adds to total output, but at a diminishing rate

consumer price index (CPI)

an index of the average prices paid by urban consumers for a typical market basket of consumer goods and services. aka cost of living index CPI=(cost now/base cost)x100

producer price index (PPI)

an index of the average prices received by domestic producers for their output

willingness-to-pay (WTP)

an individual's valuation of a good or service, equal to the most an individual is willing and able to pay

natural monopoly

an industry in which one firm can achieve economies of scale over the entire range of market supply

increasing cost industry

an industry that faces higher per unit production costs as industry output expands in the long run

All of the following are functions of money EXCEPT: as a medium of exchange. as a unit of account. as a standard value. as a store of value.

as a standard value

long run industry supply curves

as industry expands, costs can increase, remain the same, or decrease

assets and liabilities for banks

assets- cash reserves and loans made liabilities-- deposits by customers

why is the LRAS curve vertical?

b/c prices and wages adjust, so output is not affected by the price level in the long run.

why is the SRAS curve upward sloping?

b/c prices and wages are sticky in the short run, so firms respond by increasing output when prices rise

why is the PPF graph concave?

because opportunity costs rise as more factor are used to produce increasing quantities of one product

corporation

body authorized by law to act as a single person and to have rights and duties. In addition it can issue stock to raise capital

GDP deflator

broadest measure of inflation, it is an index of all goods and services in the economy, including consumer goods, investment goods, gov't goods and services, and exports

Developing countries can achieve higher productivity per unit of capital because they can use technologies developed by other countries. This is known as the:

catch-up effect.

marginal propensity to consume (MPC)

change in consumption / change in income

marginal propensity to save (MPS)

change in savings/ change in income

third-degree price discrimination

charging different groups of people different prices based on varying elasticities of demand. ex. airline, bus, and movie theatre tickets

perfect (first degree) price discrimination

charging each customer the maximum price each is willing to pay, thereby expropriating all consumer surplus-- online auction

The idea that a change in the money supply would affect prices but not real GDP is associated with the:

classical monetary transmission mechanism.

rival and nonexclusive good ex

common property resource-- ocean fishery or highway

the income approach to calculating GDP

compensation of employees (wages, salaries and benefits + proprietors' income + corporate profits + net interest + miscellaneous adjustments

total surplus

consumer surplus + producer surplus, a measure of the overall net benefit gained from a market transaction

The largest component of GDP is:

consumption expenditure.

the determinants of aggregate demand include the components of aggregate spending:

consumption spending investment spending government spending net exports

sunk costs

costs that are made in the past and cannot be recovered ex. reason why you shouldn't keep snowboarding with a broken wrist, even when you payed $100 for a full day pass

fixed costs

costs that remain constant as output changes, often called over-head

variable costs

costs that vary with the quantity of output produced, including costs such as labor and material costs

withdrawals

decrease spending in an economy, and include savings (S), taxes (T), and imports (M)

causes of inflation

demand factors: consumer confidence, income, or wealth supply shocks: when input prices increase, this not only raises the cost of living for individuals, but also raises the cost for businesses to produce and transport goods once produced government policy: when too much money (printed) chases a fixed quantity of goods and services, prices are bid up, leading to inflation

demand and supply shocks

demand shocks affect the AD curve: -caused by: consumer confidence, business sentiment, or export demand - monetary policy is more effective because targeting one goal automatically targets the other supply shocks affect the SRAS curve: - caused by changing input prices or technological innovation - monetary policy is less effective because targeting one goal makes the other target worse

An increase in the interest rate causes the aggregate _____ curve to shift _____.

demand; left

_____ is a reduction in the rate of inflation.

disinflation

he 45-degree line in the Keynesian model represents a set of points where _____ equals _____.

disposable income; consumption

how is CPI calculated

dividing market basket's cost in current period by its cost in the base period times 100

unemployed

does not have job, but is available for work and has been actively searching for the previous four weeks

problems with CPI

doesn't measure public goods doesn't take into account things like environment, homeland security, life expectancy, crime rates tends to overstate inflation due to product substitution, quality improvements, and the introduction of new products only accounts for out-of-pocket spending on health care, and not the overall health care spending

main factors of economic growth

economic freedom strong and fair legal system stable monetary system

what is the most important factor influencing a country's standard of living?

economic growth

factors that shift the supply of loanable funds

economic outlook incentives to save income or asset price government deficits

gov't is a guarantor of economic growth

enforcement of contracts, protection of property rights, stable financial system, and promoting free and competitive markets

constant cost industry

entry (or exit) does not shift the cost curves of firms in the industry

decreasing cost industry

entry of new firms shifts the cost curves for all firms downward

normal profits

equal to zero economic profits, where P=ATC

two basic determinants of economic growth

expanding resources and improving technologies

determinants of investment demand

expectations, technological change, operating costs, capital goods on hand

tax burden with elastic demand and inelastic supply

falls mostly on producer

Assume initially that market interest rates are 7% and the bondholder is receiving a $70 coupon payment per year on a bond with a face value of $1,000. If market interest rates rise to 8%, the bond price:

falls to $875.

tight money or restrictive monetary policy

fed actions designed to decrease excess reserves and the money supply to shrink income and employment, usually to fight inflation.

The U.S. gross domestic product is equal to the total market value of all:

final goods and services produced by resources in the United States.

financial intermediaries

firms that help to channel funds from savers to borrowers-- includes banks, mutual funds, insurance companies

The long-run aggregate supply curve uses the classical assumptions that all variables are _____ in the long run and that long-run equilibrium occurs at _____.

flexible; full employment

Core inflation is found by removing _____ from the consumer price index.

food and energy

Fed's objectives

full employment, stable prices, and moderate long-term interest rates

substitutes

goods consumers substitute for one another depending on their relative prices, such as coffee and tea. Substitutes have a positive cross elasticity of demand.

luxury goods

goods that have income elasticities greater than 1. When consumer income grows, demand for luxury goods rises more than the rise in income.

inferior goods

goods that have income elasticities that are negative. when consumer income grows, demand for inferior goods falls.

normal goods

goods that have positive income elasticities less than one. when consumer's income rises, demand for normal goods rises, but less than the rise in income

Open market operations involve the purchase and sale of:

government securities

for a given demand of some products, the higher the price elasticity of supply, the ______ the share of the total tax burden shifted to consumers

greater

for a given supply of some products, the lower the price elasticity of demand, the ______ the share of the total tax burden shifted to consumers

greater

decision lag

he time it takes Congress and the administration to decide on a policy once a problem is recognized.

coase theorem

if transaction costs are minimal, private bargaining will result in an efficient allocation of resources, thus socially optimal level of production will be reached

difference between short and long run (2 things)

in the short run, one factor of production is usually fixed, such as the firm's plant size, and firms cannot leave or enter the industry

effect of an excise tax on airline tickets

in this case, producers and consumers share the burden of the tax​​ equally

In the Keynesian model, the principal determinant of saving is:

income

what is the main determinant of consumption and saving?

income

reasons why LRAS curve might shift:

increase in technology greater human capital trade innovation and R&D

When current real output exceeds potential real output, the Federal Reserve will _____ interest rates in an effort to fight _____

increase; inflation

A rising aggregate price level _____ an economy's interest rates and therefore _____ output demanded.

increases; reduces

Which of the following policies do supply-side economists believe is the best for increasing the standard of living?

increasing investment in capital that boosts worker productivity

ways to expand resources:

increasing labor and human capital (investment in human capital) and increasing the capital used throughout the economy (brought about by investment)

The largest source of federal government revenues is:

individual income taxes

An expansionary fiscal policy can result in:

inflation and a higher GDP

what are known as twin evils in modern macroeconomics

inflation and unemployment

The _____ lag is the time policymakers must wait for economic data to be collected, processed, and reported.

information

factors that shift SRAS curve?

input prices productivity taxes and regulations market power of firms inflationary expectations

bond prices and interest rates are ______ related

inversely

shifts in the demand for loanable funds

investment tax incentives technological advances regulations product demand business expectations

gross private domestic investment (GPDI)

investments in things such as structures (residential and non), equipment , and software, and changes in private inventories

injections

investments, gov't spending, and exports (all increase spending in an economy)

allocative efficiency

is a state of the economy in which production represents consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing.

According to public choice theorists, deficit spending:

is undertaken as a politically palatable way of funding programs.

reasons for market failure (4)

lack of competition, asymmetric information, the existence of external benefits/costs, the existence of public goods

factors of production

land (N), labor (L) including human capital, capital (K) which are manufactured goods used in production process, and entrepreneurship ability (A)

added government spending leads to a ___ increase in GDP when compared to the same reduction in taxes

larger

long-run adjustments with short-run economic losses for perfectly competitive firms

leads to the short-run economic losses shown in the shaded area in panel B, thus inducing some firms to exit the industry. Industry output contracts to QL in panel A, raising prices to PL and expanding output for the individual firms remaining in the industry, as the industry moves to long-run equilibrium at point b. Again, in the long run, firms in perfectly competitive markets will earn normal profits, as shown by point b in panel B.

a stronger dollar will shift the U.S. aggregate demand curve to the _____ and _____ output demanded.

left; decrease

national income and product accounts

lets economists judge our nation's economic performance , compare US income and output to that of other nations, and track the economy's condition over the course of a business cycle

economies of scale

long-run average total cost falls as the quantity of output increases

The focus of supply-side fiscal policies is on:

long-run economic growth

We are most likely to see a recession if interest rates on long-term bonds are:

lower than interest rates on short-term bonds.

Checking deposits generally have a _____ return on investment than do certificates of deposit because checking deposits are _____.

lower; more liquid

The short-run aggregate supply curve is positively sloped because:

many input prices are slow to change in the short run.

_____ is the change in consumption associated with a change in income.

marginal propensity to consume

equilibrium

market forces are in balance when the quantities demanded by consumers just equal the quantities supplied by producers

total factor productivity

measure of productivity including all things how quantity and quality of inputs could influence production

price elasticity of supply

measures the responsiveness of quantity supplied to changes in price of the product.

properties of money

medium of exchange, unit of account, store of value, liquidity

unit of account

money provides a yardstick for measuring and comparing the values of a wide variety of goods and services. It eliminates the problem of double coincidence of wants associated with barter.

If the pound sterling appreciates against the U.S. dollar, England buys _____ U.S. goods, causing the U.S. aggregate demand curve to shift to the _____.

more; right

In the equation of exchange, the term P × Q is the same as:

nominal GDP

multiplier effect

occurs when a dollar of spending generates more dollars of spending in the economy

market failure

occurs when a free market does not lead to a socially desirable outcome

misallocation of resources

occurs when a good or service is not consumed by the person why values it the most, and typically results when a price ceiling creates an artificial shortage in the market

short run growth

occurs when an economy makes use of existing or under-utilized resources, as seen as a movement from inside PPF towards PPF

change in demand

occurs when one or more of the determinants of demand changes, shown as a shift in the entire demand curve

change in supply

occurs when one or more of the determinants of supply change, shown as a shift in the entire supply curve

change in quantity supplied

occurs when the price of a product changes, shown as a movement along an existing supply curve

changes in quantity demanded

occurs when the price of the product changes, shown as a movement along an existing demand curve

comparative advantage

one country has a lower opportunity cost of producing a good than another country

The main tool of monetary policy is:

open market operations

average product

output per worker-- found by dividing total output by the number of workers employed to produce that output

examples of perfect competition firms

paper for copy machines, agricultural products, computer memory chips

rate of return regulation

permits product pricing that allows the firm to earn a normal return on capital invested in the firm

The four types of spending in GDP are

personal consumer spending, gross private domestic investment, government spending, and net exports

role of gov't in promoting economic growth

physical capital: building/maintenance of country's public capital human capital; providing subsidized public education, financial aid grants, and loans technology: funding research via grants and the establishment of major government research labs

discouraged workers

portion of marginally attached workers who have given up actively looking for work and, as a result, are not counted as unemployed

second-degree price discrimination

practice of charging different prices per unit for different quantities of the same good or service

unitary elastic supply

price elasticity of supply is equal to 1. The percentage change in quantity supplied is equal to the percentage change in price Es=1

elastic supply

price elasticity of supply is greater than 1. The percentage change in quantity supplied in greater than the percentage change in price Es>1 elastic supply curves always cross the price axis-- are more flat

inelastic supply

price elasticity of supply is less than 1. The percentage change in quantity supplied in less than the percentage change in price Es<1 inelastic supply curves always cross the quantity axis-- more vertical

total revenue

price per unit times quantity sold

total revenue

price x quantity

capital/market economies

private firms and individuals own most of the resources

long run

production period long enough to adjust all factors of production, including plant capacity

determinants of supply (6)

production technology costs of resources prices of related commodities expectations the # of sellers (producers) in the market taxes and subsidies

Which is a determinant of aggregate supply?

productivity

productive efficiency

products are produced and sold to customers at their lowest possible opportunity cost

monopolistic competition

products that are similar but not identical many buyers and sellers differentiated products little to no barriers to market entry or exit no long-run economic profit some control over price (limited market power) a market structure in which many companies sell

economic profit

profit in excess of normal profits. These are profits in excess of both explicit and implicit costs

x-inefficiency

protected from competitive pressures, monopolies do not have to act efficiently. ex. spending money on luxury corporate jets, lavish travel, and more nonessential perks.

nonrival and exclusive good ex

public good with exclusion, such as cable tv or satellite radio

rival and exclusive good ex

pure private good. airline seat.

nonexclusive and nonrival good ex

pure public good-- national defense or public broadcasting

High taxes and/or heavy regulation:

raise costs of production so that the aggregate supply curve shifts to the left.

GDP deflator equation

real = nominal x (base year index/current year index)

what two gaps occur when economy moves away from full employment equilibrium?

recessionary gap and inflationary gap

losses associated with monopolies

reduced output at higher prices, deadweight losses, rent-seeking behavior of monopolists, and x-inefficiency losses

Which of the following is an example of contractionary fiscal policy?

reducing military spending

When a financial institution provides a standardized financial product such as a mortgage, it is:

reducing transaction costs.

_____ government spending, _____ transfer payments, and _____ taxes are all examples of contractionary fiscal policy.

reducing, reducing, raising

incidence of taxation

refers to who bears the economic burden of the tax, which is determined by the price elasticities of demand and supply

marginal cost pricing rule

regulators would prefer for natural monopolists to price where MC=P, but this would result in losses in the long run, as ATC>MC

average cost pricing rule

requires a regulated monopolist to produce and sell output where price equals average total cost. This permits the regulated monopolist to earn a normal return on investments over long run, and therefore remain in business

long-run growth

requires an expansion of production capacity through an increase in resources and/or technology (WHOLE PPF curve shifts outward0

rent seeking

resources expended to protect a monopoly's position. ex. lobbying, extending patents, etc. it is behavior directed towards avoiding competition

automatic stabilizers

revenues and transfer payments automatically expand or contract in ways that reduce the intensity of business fluctuations without any overt action by Congress or other policymakers.

If oil prices decline, the short-run aggregate supply curve shifts _____ and output supplied will _____.

right; increase

Increased consumer confidence will shift the aggregate demand curve to the _____ and _____ output demanded.

right; increase

The crowding-out effect recognizes that if the government sells bonds to finance spending, it can cause interest rates to _____ investment.

rise, thereby reducing

Which list represents monetary policy actions that are consistent with one another?

sell government bonds, raise reserve requirements, raise the discount rate

long run adjustments with short run losses (perfectly competitive industry)

short run losses cause some firms to exit, raising the price and moving the demand curve up to the ATC curve so normal profits are made

Cost-push inflation is a situation in which the:

short-run aggregate supply curve shifts leftward.

aggregate supply curve

shows the real GDP firms will produce at varying price levels

The largest category of federal government spending in 2015 was:

social security

mandatory spending

spending authorized by permanent laws that does not go through the same appropriations process as discretionary spending. Mandatory spending includes Social Security, Medicare, and interest on the national debt.

GDP can be found either by adding up all of the _____ or all of the _____ in the economy.

spending; income

If a product becomes obsolete and the workers who produced that product will need additional training to find new jobs, then they are experiencing:

structural unemployment

long run adjustments with short run economic profits (perfectly competitive industry)

supply shifts from S2 to S1 as more firms enter, which drives prices from P2 to P1 In the long run, this causes firms in perfectly competitive markets to earn only normal profits

planned economies (socialist and communist)

systems in which most of the productive resources are owned by the state and most economic decisions are made by central governments

determinants of demand

tastes/preferences income prices of related goods # of buyers expectations about future prices, incomes and product availability

Which organization determines the beginning and end dates of a recession?

the National Bureau of Economic Research

Which of the following groups must agree in order to implement fiscal policy?

the Senate, House of Representatives, and executive branch

absolute advantage

the ability to produce more of a given product than another producer/country using a given amount of resources

price level

the absolute level of a price index, which can included Consumer Price index (CPI; retail prices), producer price index(PPI; wholesale prices), or the GDP deflator (avg pricing of all items in GDP)

If banks increase excess reserves to increase their ability to absorb a higher rate of defaults:

the actual multiplier will fall.

marginal revenue

the additional income from selling one more unit of a good; equal to price in a perfectly competitive firm MR = ΔTR/Δq

deficit

the amount by which annual government expenditures exceed tax revenues.

price discrimination

the business practice of selling the same good at different prices to different customers

marginal propensity to consume

the change in consumption associated with a given change in income (change in C/change in Y)

marginal propensity to save

the change in savings associated with a given change in income (change in C/change in Y)

marginal revenue

the change in total revenue from selling an additional unit of output MR= ΔTR/Δq marginal revenue is equal to price in perfectly competitive firms!!

consumption income graph

the consumption line starts above the origin on the vertical axis, because even w/ no income, one still consumes by borrowing as income increases, consumption rises, but not as fast as income

producer surplus

the difference between the current market price and the cost of production for the firm

consumer surplus

the difference between the willingness to pay for a good and the price that is paid to get it

accounting profit

the difference between total revenue and explicit costs. These are the profits that are taxed by the government

CONTRACTIONARY FISCAL POLICY TO REDUCE INFLATION

the economy is overheating at point e, with output above full employment. Contractionary policies reduce aggregate demand to AD1, bringing the economy back to full employment at price level P1. These policies prevent an inflationary spiral, but the fall in aggregate output leads to an increase in unemployment.

If a government always balances its budget:

the effect of an increase in government spending on aggregate expenditures is weakened.

personal consumption expenditures

the expenditures of households for durable and nondurable consumer goods and services in the United States

who makes decisions in the fed

the federal open market committee (FOMC)-- has 12 members

marginal product

the increase in output that arises from an additional unit of input (change in quantity over change in labor)

Firms decide how much to invest by comparing the rate of return on their projects with:

the interest rate.

short-run supply curve

the marginal cost curve above the minimum point on the average variable cost curve THIS WAS A TEST QUESTION LAST TIME

gross domestic product (GDP)

the market value of all final goods and services produced within a country in a given period of time

gross national product (GNP)

the market value of goods and services produced by labor and property supplied by U.S. residents

Monetary targeting is setting a steady growth rate in:

the money supply

Which of the following tends to make aggregate demand decrease by more than the amount that consumer spending decreases?

the multiplier effect

implicit costs

the opportunity costs of using resources that belong to the firm, including depreciation, depletion of business assets, and the opportunity cost of the firm's capital employed in business

A production function shows:

the output that is produced using different combinations of inputs combined with existing technology

discretionary spending

the part of the budget that works its way through the appropriations process of congress each year and includes national defense, transportation, science, environment, and income security

elastic demand

the percentage change in quantity demanded is greater than the percentage change in price. This results in the absolute value of the price elasticity of demand to be greater than 1 goods with elastic demands are very responsive to changes in price

average propensity to save (APS)

the percentage of income saved (S/Y)

average propensity to consume (APC)

the percentage of income that is consumed (C/Y)

diseconomies of scale

the property whereby long-run average total cost rises as the quantity of output increases. firms oftentimes become so big that management becomes bureaucratic and unable to control its operations efficiently

constant returns to scale

the property whereby long-run average total cost stays the same as the quantity of output changes ex the expansion of fast-food restaurant chains/movie theaters reflect this

As the real interest rate falls:

the quantity demanded of loanable funds rises.

what does the aggregate demand curve show?

the quantity of goods and services (real GDP) demanded at different price levels

deadweight loss

the reduction in total surplus resulting from a market not being in competitive equilibrium

normal profits

the return on capital necessary to keep investors satisfied and keep capital in the business over the long run

macroeconomics

the study of economy-wide phenomena, including inflation, unemployment, and economic growth

economic costs

the sum of explicit (out-of-pocket) and implicit (opportunity) costs

total cost

the sum of fixed costs plus variable costs-- all costs associated with running a business, including out-of-pocket expenses and opportunity costs

tragedy of the commons

the tendency for a resource that has no price to be used until its marginal benefit falls to zero

short run

the time period in which at least one input is fixed

short run

the time period when plant capacity and the number of firms in the industry cannot change. (nobody can enter or leave the market)

explicit costs

those expenses paid directly to another economic entity, including wages, lease payments, taxed, and utilities

primary determinant of price elasticity of supply

time

long run

time period is long enough for plants to alter their capacities and for the number of firms in the market to change.

average fixed cost

total fixed cost divided by the quantity of output

labor force

total number of those employed and unemployed

profit

total revenue minus total cost

informal economy

transfers of money, goods, or services that are not reported to the government (black market)

complements

two goods that are bought and used together. have a negative cross elasticity of demand

structural unemployment

unemployment caused by changes in the structure of consumer demands or technology

frictional unemployment

unemployment resulting from workers who voluntarily quit their jobs to search for better positions

cyclical unemployment

unemployment that results from changes in the business cycle

price system

uses monetary prices as a message system to facilitate exchanges between buyers and sellers

real GDP vs nominal GDP

using real GDP instead of nominal GDP allows a country to compare growth from year to year w/o having to account for inflation

demand for public goods graph

vertical summation of individual demand curves

government spending

wages/salaries of govt employees, the purchase of products and services from private businesses and the rest of the world, and purchases of new structures and equipment

determinants of consumption and saving

wealth, expectations, household debt, and taxes

crowding-out effect

when deficit spending requires the government to borrow, interest rates are driven up, reducing consumer spending and business investment.

price elasticity and total revenue along a straight-line (linear) demand curve

when price falls from 20 to 18, revenue rises, but as we move down the demand curve, elasticity equals one (unitary) and after that, when price falls, revenue declines

shutdown point for perfectly competitive firm

when price in the short run falls below the minimum point on the AVC curve

why is the aggregate demand curve downward sloping?

when price levels rise, the purchasing power of money falls (wealth effect)

total revenue and relatively elastic demand

when products have an elastic demand, it is usually because substitutes are available, so firms feel a greater impact from changes in price. A small rise in price causes sales to fall off dramatically.

economies of scale

when the average total cost declines with increased production

allocative efficiency

when the mix of goods being produced represents the mix that society most desires

total revenue and relatively inelastic demand

when the price rises, revenue rises because the revenue gained from the price hike is greater than the revenue lost from fewer sales

in a perfectly competitive firm, when does the firm maximize profits?

where MC=MR

underemployed workers

workers who are forced to take jobs that do not fully utilize their education, background, or skills

marginally attached workers

workers who were available to work and actively looked for it during the last 12 months, but not in the last four weeks

aggregate production function

y=Ak^(1/3)h^(2/3)

how does a change in taxes affect a change in income?

ΔY=[MPC/(1-MPC)]ΔT