macro exam 2

contraction

a period of economic decline marked by falling real GDP

budget deficit

a situation in which the government spends more than it takes in

budget surplus

a situation in which the government takes in more than it spends

positive output gap

actual > potential (strong AE)

The IS curve is constructed by:

adding up the level of aggregate expenditure at each real interest rate.

Credit constraints limit the

amount of money that people can borrow.

Hyperinflation

an extremely high rate of inflation.

mutual fund

an investment program funded by shareholders that trades in diversified holdings and is professionally managed.

medium of exchange

an item that buyers give to sellers when they want to purchase goods and services - money for a good

level of savings

real income - real consumption

What drives investment?

real interest rate

money illusion is the

tendency to focus on nominal values instead of inflation-adjusted values.

liquidity

the ability to quickly and easily convert investments into cash with little or no loss in value

compounding

the accumulation of money over time as interest is earned

If actual GDP is greater than potential GDP:

the economy can experience inflation.

risk premium

the extra interest that lenders charge to an account for the risk of loaning money

output gap

the gap between real GDP and potential GDP

peak

the highest point in the business cycle

MPC (marginal propensity to consume)

the increase in consumer spending when disposable income rises

risk-free interest rate

the interest rate at which money can be borrowed or lent without risk over a given period

Great Moderation

decreased volatility of the US economy

expansion

A period of economic growth as measured by a rise in real GDP

Recession

A slowdown in a nation's economy

efficent market hypothesis

A theory that describes what type of information are reflected in current stock prices

output gap formula

((actual output - potential output)/potential output) X 100

rate of inflation formula

(Current CPI - Old CPI) / Old CPI

MP (monetary policy) curve

- shows the current real interest rate - controlled by the Fed

GDP multiplier formula

1/(1-MPC)

inflation

A general increase in prices

Depression

A long-term economic state characterized by unemployment and low prices and low levels of trade and investment

spending shocks

Any change in aggregate expenditure at a given real interest rate and level of income. Spending shocks shift the IS curve.

financial shocks

Any change in borrowing conditions that changes the real interest rate at which people can borrow. Financial shocks shift the MP curve.

CPI formula

Current basket/base basket X100

Business investment =

Equipment + Business structures + Intellectual property

Present Value Formula

FV/(1+ir)^n

Okun's rule of thumb

For every 1 percentage point that actual output falls below potential output, the unemployment rate rises by 0.5

Leading vs Lagging Indicators

Leading indicator → variable to predict the future path of the economy Lagging indicator→ variables that tend to follow the business cycle movements

Real GDP formula

Nominal GDP/GDP Deflator x 100

GDP deflator equation

Nominal GDP/Real GDP x 100

rational rule for investors

Pursue an investment opportunity if the present value of future revenues exceeds the up-front cost

The three major pillars of the financial sector are the:

banks, bond market, stock market

MPC formula

change in consumption/change in income

The slope of the consumption function is equal to

change in consumption/change in income (same thing as MPC)

stock prices can predict

changes in GDP

what causes shifts to the MP curve

changes in monetary policy financial shocks

how do you find the current cost with old and current CPI given

current CPI/old CPI x cost

depreciation

decline in capital due to wear and tear, damage, and aging

A decrease in investment demand

demand shifts left interest rates decrease

Increase in investment demand

demand shifts right interest rates increase

Four stages of the business cycle

expansion, peak, recession, trough

Government expenditure

government consumption

budget deficit

government spends more than it takes in

budget surplus

government takes in more than it spends

consumption smoothing

having a balance between saving and consuming to optimize a persons living standard

how do interest rates affect investment

higher interest rates = investment falls

Market Capitalization

how much a company is worth

what is the relationship between capital stock and depreciation

if depreciation is greater than capital investment capital stock goes down (vice versa)

S&P 500

index that shows the price changes of different stocks

What drives investment?

interest rates

trough

lowest point of a recession

the intersection of the IS and MP curve determine

macroeconomic equilibrium

rational rule of consumption

marginal benefit of consumption of a dollar today is greater than the marginal benefit of spending a dollar plus interest in the future.

menu costs

marginal costs to firms of changing prices

Functions of Money

medium of exchange, unit of account, store of value

Net Financial Outflow

money leaving a buisness

planned investment

money spent on capital stock that is planned by firms

real interest rate vs nominal interest rate

nominal - does not take in inflation real - inflation adjusted

real rate of return formula

nominal rate - inflation rate

If the consumer price is lower than last year

on average in the economy prices went down

consumption is based on

permanent income

negative output gap

potential > actual (weak AE)

Future Value Formula

present value (1+IR)^n

the fundamental value of a business

present value of the future profit it will earn

user cost of capital formula

price x (depreciation + real interest rate)

difference between saving and investment

saving: money left over from spending investment: purchase of new capital

loanable funds market

shows the demand for funds generated by borrowers and the supply of funds provided by lenders

IS (investment savings) curve

shows the relationship between real interest rate and ouput gap

what causes shifts to the IS curve

spending shocks occur

GDP deflator tracks

the price of all goods and services produced domestically

default risk

the risk of not getting paid

Liquidity Risk

the risk that your bond will not resell of you need the funds quickly

capital stock

the total quantity of capital at a point in time

inflation rate between last year and this year

total basket goods this year - total basket goods last year / cost of basket goods last year

multiplier formula

total gdp / government spending

Aggregate Expenditure

total spending on final goods and services in an economy AE = C+I+G+NX

term risk

uncertainty about future interest rates since your money will be tied up in a bond

what is the output gap when potential = actual

zero