ECO-303 Final Exam Notes

What are the effects of a decrease in the current capital stock on the real interest rate, aggregate output, employment, real wage, consumption, and investment

A decrease in current capital stock will lea to an increase in real interest rate and investment It also leads to a decrease in aggregate output, real wage and consumption

What is the effect on desired national saving of a lump-sum tax increase

A lump sum tax increase leads to a decrease in desired consumption and increase in desired savings because households have less disposable income and chose to save now.

What effect does a one time improvement in productivity have on long-run living standards, according to the Solow model

A one-time increase in productivity increases living standards directly, by increasing output and raising savings and capital stock indirectly

What produces a larger increase in consumer's current consumption, a permanent increase in the consumer's income, or a temporary increase?

A permanent increase will not change the proportion of consuming and savings, but will increase current consumption indefinetly A temporary increase will increase savings because te consumer knows the increase is temporary

What effect does a temporary increase in government purchases have on the labor market, according to classical theory

A temporary increase in government purchases will increase real interest rates, aggregate output, and employment. It will lead to a decrease in real wage rate, consumption, and investment

What effect does a temporary increase in government spending have on desired consumption and desired national saving

A temporary increase in government spending leads to a increase in desired consumption and decrease in desired national saving because households take this as an indicator that they will earn more in the future, so they spend more now and save less

Explain why a temporary increase in real wage increases the amount of labor supplied, but a permanent increase in the real wage may decrease the quantity of labor supplied

A temporary increase in real wage increases labor supply because of the higher real wage substitution effect. The worker will be more willing to work extra hours to take advantage of the temporary opportunity. In a permanent wage increase, the income effect will take place because the worker will have more income to cover expenses and enjoy more leisure,

How is optimal investment for the firm affected by an increase in the current capital stock?

An increase in current capital stock leads to a decrease in optimal investment because the firm already has enough capital to produce at its desired output level

What are the effects of an increase in current total factory productivity in the real intertemporal model

An increase in current total productivity leads to an immediate increase in output and income without affecting future expectations

How is optimal investment affected by an increase in future total factor productivity

An increase in future total factor productivity leads to an increase in optimal investment because the firm expects to produce more output with the same level of inputs in the future

In a one-period general equilibrium model, what are the effects of an increase in government purchases? why does government spending crowd out government purchases?

An increase in government spending increase demand for goods, which can lead to higher prices and interest rates. Government spending crowds out private investment because it competes with the private sector for resources. The more government spends, the lower the supply of the good, but the demand and price will rise

What are the effects of an increase in the real interest rate on consumption in each period, and on savings? How does this depend on income and substitution effects and whether the consumer is a borrower or lender?

An increase in real interest rate makes current consumption more expensive It encourages saving and discourages consumption.

What effect does an increase in the population growth rate have on long-run living standard, according to the Solow model

An increase in the population growth rate reduces long-run living standards as more output has to be made to equip new workers, leaving less output per worker

What effect does an increase in the saving rate have on long-run living standards according to the Solow model?

An increase in the saving rate increases long run living standards as higher savings allow more investment and larger capital stock

How is the worker's behavior affected by an increase in unearned income? Why might hours worked by the workers decrease when the real wage increases?

An increase in unearned income will increase consumption and saving. The real wage increases, so do the opportunity cost of leisure, making working more attractive

What are the two components on user cost of capital

Interest cost and Depreciation cost

Why might the income effect increase or decrease savings depending on whether somebody is a lender or borrower

Borrowers save more when interest rates increase because higher rates make them worse off Lenders saving behavior is ambiguous since the income and substitution effects work in opposite directions

What are the effects of an increase in current income on consumption in each period, and on savings

For the lender, effects on consumption and savings are ambiguous while change in consumption increases For the borrower, consumption decreases, savings increase, changes in consumption are ambiguous

If the government announces a deficit-financed tax cut, but government spending is unchanged, how would household consumption and savings be affected

Household consumption will increase because households have more disposable income due to low taxes. As a result, savings may decrease since households will want to consume more in the present rather than the future.

Determine the equilibrium effects of an anticipated increase in future total productivity in the real intertemporal model

If people anticipate an increase in future productivity, they will save more and consume less in the present. This increases expected return on investment, and icnreases the real interest rate

Explain how beliefs that a bank could be in financial distress can cause the bank to end up in financial distress

If people think a bank may be in trouble or their money is not safe in a bank, they will rush to take if out. If alot of people do this at the same time, the bank will have financial problems because banks never have that much capital on hand. A way to counter this is offering deposit insurance

According to the solow model, if there is no productivity growth, what will happen to output per worker, consumption per worker, and capital per worker in the long run?

If there is no productivity growth, output per worker, consumption per worker, and capital per worker will be constant in the long run, representing a stead state

Define the inflation tax (seignorage)

Inflation tax is the tax the government collects by creating money

Explain why the profit maximization level of employment for a firm occurs when the marginal revenue product of labor equals the nominal wage

It is not efficient for a firm to pay its workers more than it will earned in revenues from that labor

Describe three alternative responses available to policymakers when the economy is in recession and their effects

Make no changes Increase money supply (lower interest rates to increase borrowing, but could increase debt burden) Increase government spending (can stimulate aggregate demand and reduce unemployment, but can lead to inflation

Suppose the federal government has 2 options: (1): A uniform tax on all income (2): A uniform tax on all expenditures Would consumers have a preference for one policy or the other?

No they would not have a preference because these policies are equivalent in terms of economic impact

When the consumer chooses his or her optimal consumption under while respecting his or her budget constraint, what condition is satisfied?

Optimization: The point where the highest possible indifference curve meets the budget constraint

What relationship does the LM curve capture

The LM Curve represents the equilibrium relationship between the interest rate and output

What is the Phillips curve?

The Phillips curve describes the relationship between inflation and unemployment

What determines the demand for money in the monetary intertemporal model

The demand for money depends on interest rates. Money demand increases as interest rates rise

What are the effects on an increase in future income on consumption in each period, and on savings

The effect on consumption and savings are ambiguous, while the change in consumption increases

What are the effects of an increase in the money supply in the monetary intertemporal model

The effects of an increase in the money supply in the monetary intertemporal model are a short run increase in inflation and long run increase in nominal values

What are the factors that shift the output demand curve

The factors that shift the output demand curve are change in consumer income, and change in consumer preferences

What are the factors that shift the output supply curve

The factors that shift the output supply curve are changes in production cost, technology, price, or number of firms

How are the incentive effects of income taxation important for the Laffer curve? What happens when the economy is on the Laffer curve's bad side?

The incentive effects are important becuase they show that as the tax rate increases, there is a point where tax revenue decreases because of decreased economic activity If the economy falls on the bad side of the Laffer curve, the tax revenue will rise.

Explain why the investment curve slopes downward in the saving-investment diagram

The investment curve slopes downward because as interest rates increase, it becomes more expensive for firms to borrow money to invest, leading to a decrease in investment example: increase in government spending

How are the real interest rate, nominal interest rate, and inflation rate related to one another

The real interest rate is the nominal interest rate - the rate of inflation

Explain why the saving curve slopes upward in the saving-investment diagram

The savings curve slopes upward because interest rates increase, people save more, and as interest rates decrease, they save less example: increase in household income

Explain why the effect on desired saving of an increase in the expected real interest rate is potentially ambiguous

The substitution effect makes people save more when interest rates increase because they value future consumption over current consumption The income effect may increase or decrease savings depending on whether somebody is a lender or borrower

According to the growth accounting approach, what are three sources of economic growth? From what basic economic relationship is the growth accounting approach derived?

The three sources of economic growth are capital growth, labor growth, and productivity growth The growth accounting approach is derived form the production function

Define the velocity of money

The velocity of money estimates the movement of money in the economy

Why might policymakers prefer to target interest rates rather than the money supply?

They might prefer to target interest rates rather than the money supply because interest rates are more visible and easier to communicate to the public

If interest rates are already very low, how is monetary policy constrained?

When interest rates are already very low, central banks cant reduce them further to stimulate the economy. A way to counter this is for policymakers to implement fiscal stimulus policies to support economic growth

Can the government always increase its real revenues from the inflation tax by increases money growth and inflation?

While increasing money growth and inflation can increase nominal government revenue, it does not necessarily increases government revenue because of the inflation tax