Econ Chapter 3, 4, 5 - Pearson HW and Terms
Production Function Equation
A description of how much output is produced for any given amounts of factor inputs Y = F(K,L) Production = .Function(Capital,Labor)
perfect competition
A market where buyers and sellers are price takers because they are not large or powerful enough to charge more than the market price for their goods or services.
Which of the following are the three primary functions that money performs in an economy?
A medium of exchange, a unit of account, and a store of value.
Cobb-Douglas production function
A production function in which the shares of labor and capital income are constant. Y = F(K,L) Y = AK(.03)L(.07) Where capital (K) is 30% and Labor (L) is 70% The variable A described productivity or total factor productivity, telling us how productive capital and labor are. 1) Displays constant returns to scale 2) it has diminishing marginal products
Changes in Saving: Autonomous Consumption
A rise in autonomous consumption causes saving and investment to fall and the real interest rate to rise in the long run, while a fall in autonomous consumption causes saving and investment to rise and the real interest rate to fall
Changes in Saving: Effects of Fiscal Policy - Taxes
A rise in taxes causes saving and investment to rise and the real interest rate to fall in the long run, while a fall in taxes causes saving and investment to fall and the real interest rate to rise.
How does a small open economy differ from a large open economy?
A small open economy has no effect on the world real interest rate.
Value-added tax
A tax that is paid by a producer on the difference between what it receives for its goods and services minus the costs
Considering the world as two large open economies, a domestic economy and the rest of the world, the condition required for goods market equilibrium is that
A. desired world saving equals desired world investment. B. the trade surplus in one economy must equal the trade deficit in the other economy. C. the net capital outflows from one economy must match the net capital inflows from the other economy. D. the amount of borrowing by one economy equals the amount of lending by the other economy. E. all of the above are equivalent expressions for equilibrium in the goods market. E: ALL OF THE ABOVE
Board of Governors of the Federal Reserve System
The seven-member board that supervises the banking system of the United States. Appointed by the President and confirmed by the Senate. Chairperson serves a 4-year, renewable term. Headquartered in Washington, DC
Changes in excess reserves
The money supply is negatively related to the amount of excess reserves
Changes in the Required Reserve Ratio
The money supply is negatively related to the required reserve ration rr
Changes in borrowed reserves from the Fed
The money supply is positively related to the level of borrowed reserves, BR, from the Fed
net foreign assets
The net holdings of foreign assets (American-Owned foreign stocks, bonds, bank accounts, factories, etc., minus foreign owned U.S. assets)
Quantity Theory and Inflation
The quantity theory of inflation indicates that the inflation rate equals the growth rate of the money supply minus the growth rate of aggregate output
Which of the following variables changes in order to bring saving and investment into equilibrium?
The real interest rate
world real interest rate
The real interest rate found in world markets r = r^w
If desired saving increases, what happens to the real interest rate and desired investment?
The real interest rate decreases, which causes desired investment to increase.
Why do you think we do not use silver and gold coins as the preferred mean of payment anymore?
The value of coins would fluctuate with the value of gold and silver. B. The supply of gold and silver coins is physically limited by the total supply of gold and silver. C. Gold and silver are not easily portable, especially for large transactions. D. CORRECT ANSWER All of the above are reasons why silver and gold coins are not currently preferred as a mean of payment.
Tax Consumption
a high tax on consumption encourages consumers to spend less and save more, thereby amassing wealth
wealth
a person's holdings of assets (such as bonds, stocks, houses, and fine art) minus his or her liabilities, the amount he or she owes (mortgages, car loans, and credit card balances)
Open market purchase
a purchase of bonds by the Fed
open market sale
a sale of bonds by the Fed
Equation of exhange
a tautology that is always true. MV=PY Relates nominal income to the quantity of money and velocity States that the quantity of money multiplied by the number of times the money i spent in a given year must equal nominal income (the total nominal income spent on goods and services in that year.
high-powered money
aka monetary base - equals currency in circulation C, plus the total reserves i the bank system, R. Monetary base = MB MB = C + R
aggregate production function
also referred to a the Production Function is a description of how much output (Y), is produced for any given amounts of factor inputs, such as K & L
Money
an asset that is generally accepted as payment for goods and services or in the repayment of debts
closed economy
an economy that is closed to international trade with zero net exports (NX = 0)
Of the five variables identified above as relevant to the determination of the economy's money supply, those bearing a NEGATIVE relationship to the money supply are
The required reserve ratio, currency holdings, and excess reserves
Economic Profits
The revenue from selling goods and services, minus the costs of the inputs
small open economy
an economy that is open to trade and to flows of capital across its borders and that is "small" relative to the world economy so that whatever happens in this economy has no effect on the world real interest rate.
excess reserves
any additional reserves the banks choose to hold
Slope of production
as the capital stock increases, the marginal product of capital declines. There is diminishing marginal product of capital
Currency
bills and coins in our pockets - money
To reduce the budget deficit
budgetary policies such as increasing taxes and cutting expenditures can be used.
If a country has a small open economy, a decrease in autonomous investment will
cause an increase in net exports and the economy buys more foreign assets, which should not change the economy's wealth.
Classical economists view
changes in the quantity of money lead to proportional changes in the price level
The Federal Reserve influences the size of the monetary base by
conducting open market operations and extending discount loans to banks.
Reserves
consist of deposits at the Fed plus currency that is held in bank vaults
rental price of capital (R)
cost of using capital Rental price of capital = RK (8)
Profit-maximizing conditions summarized
firms demand additional quantities of each factor of production (labor and capital) until the marginal product of that factor falls to its real factor price
Hyperinflation is caused by
fiscal imbalances usually increasing the money supply in the economy
investment tax credit
gives businesses a tax break when they make an investment in physical capital, encourage businesses to expand investment at any given real interest rate and also shift the investment curve to the right.
saving-investment diagram
good market equilibrium condition, S = I, occurs at a point E at the intersection of the saving and investment curves Figure 4.5
Government Consumption (Cg)
government spending on current needs G =Cg + Ig
open economies
governments are open to trade and flows of capital across their borders
What is the difference between a closed economy and an open economy?
in an open economy, economies are open to trade with one another, while in a closed economy, there is no trading between the different economies
Shares of Labor and Capital Income
in national income do not change even as the total level of income rises and falls
unit of account
measure of value in the economy
monetary aggregate
measures of money supply M1 and M2 -
Increase Return on Saving
measures that increase the return on assets like common stock increase the incentives for households to save. Example: Bush passed legislation that lowered the tax that investors pay on capital gains.
Medium of exchange
money in the form of currency and checks, used to pay for goods and services
vault cash
money stored in bank vaults overnight.
liquid
money that does not have to be converted into a medium of exchange in order to make purchases.
The Fisher Effect predition
nominal interest rates rise along with expected inflation is accurate in the long run, but over shorter time periods, expected inflation and nominal interest rates do not always move together
perfect capital mobility
open economy does not have any restrictions on flows of capital between domestic and foreign residents or vice versa
Money Supply Process
page 134
Hyperinflation
periods of extremely high inflation of more than 50% per month
Cost of Labor
price of labor or wage rate, W Wate Rate = W x Labor or WL
How does the Fed change the monetary base
primarily through open market operations
Capital
quantity of structures and equipment, factories, trucks, and computers, that workers use to produce goods and service (K) measured by the value of the capital stock in real terms - constant dollars.
real rental price (or cost) of capital r (c)
rental price of capital in terms of goods and services, which is the nominal rental price of capital divided by the price level r(c) = (R/P)
store of value
repository of purchasing power that lasts over time, saves purchasing power from the time income is received until the time it is spent.
required reserves
reserves that the Fed requires banks to hold
positive (or favorable) supply shocks
result in an increase in the quantity of output produced for given combinations of capital and labor CAUSES THE AGGREGATE PRODUCTION TO SHIFT UPWARD AND RAISES THE MARGINAL PRODUCTS OF CAPITAL AND LABOR
Changes in the nonborrowed monetary base
results in the money supply is positively related to the nonborrowed monetary base MBn
If a country has a closed economy, a decrease in autonomous investment will
shift the investment curve to the left, decreasing the real interest rate and the levels of saving and investment, which will cause the economy's wealth to decline.
If a country has a large open economy, an increase in government surplus (or a decrease in government deficit) will
shift the saving curve to the right, which will increase net exports, and the real interest rate decreases
If a country has a small open economy, an increase in government surplus (or a decrease in government deficit) will
shift the saving curve to the right, which will increase net exports, and the real interest rate remains the same.
twin deficits
simultaneous trade deficit and government budget deficit
Government investment (Ig)
spending on capital goods like highways and schools that add to the capital stock and promote economic growth
national saving
summing private saving and government saving S = Sp + Sg = Y - C - G
labor
summing the numbers of hours people work, or person-hours (L)
money multiplier
tells us how much the money supply changes for a given change in the monetary base denoted by m M = m x MB example on page 137
shoe-leather costs
term economists use to denote the time and fuel spent on trips to the bank
Federal Reserve Banks
the 12 banks chartered by the U.S. government to control the money supply and perform other functions 5 have a vote on the Federal Open Market Committee (FOMC)
uses-of-saving identity
the accounting identity that states that private saving equals the sum of investment, the government deficit, and the current account balance
autonomous consumption
the amount of consumption expenditure that is unrelated to either disposable income or the real interest rate
money supply
the amount of money in the national economy
Diminishing marginal product
the amount of one factor input increases, holding other inputs constant, the increased amount of output from extra unit of input declines
labor productivity
the amount of output produced per unit of labor measured by dividing measured output by the amount of labor input Drawbacks: labor productivity can rise even when the productivity of labor and capital together are falling.
Federal Reserve System (FED)
the central bank of the United States
menu costs
the costs a firm bears when it changes the price of its goods
net capital outflow or net foreign investment
the difference between saving and investment S - I
capital gains
the difference between the sale and purchase price of an asset like stock or a house.
borrowed reserves
the discount loans banks have taken out from the Feds
whether a bank chooses to use its excess reserves to make loans or to purchase securities,
the effect on deposit expansion is the same
required reserve ratio
the fraction held as reserves denoted as rr
marginal product
the increased output form an extra unit of the input
National income is divided between payments to labor and the payments to capital, with the size of these payments determined by
the marginal products of labor and capital.
nonborrowed monetary base
the monetary base minus banks' borrowing from the Fed (discount loans)
Changes in currency holdings
the money supply is negatively related to currency holdings
Of the five variables identified above as relevant to the determination of the economy's money supply, those bearing a positive relationship to the money supply are
the nonborrowed monetary base and borrowed reserves
private saving rate
the proportion of private disposable income that is saved Sp/Yd
neutrality of money
the proposition that in the long run, changes in the quantity of money affect the price level but do not affect any real quantities
demand for money
the quantity of money that people want to hold M = 1/V x PY
crowding out
the rise in government spending causes private investment to fall as government spending increases.
national saving rate
the share of national income saved by the government and households, or S/Y.
monetary base
the sum of the Fed's monetary liabilities and the U.S. Treasury's monetary liabilities (treasury currency in circulation, primarily coins)
transaction costs
the time and money spent exchanging goods or services.
Wealth
the total collection of property that serves as a store of value, includes money and other assets
real wage rate
the wage in term of goods and services which can be written as the nominal wage rate divided by the price level, w = (W/P)
quantity theory of money
view that nominal income (spending) is determined solely by movements in the quantity of money
Fisher effect
when inflation rises, interest rates will rise.
excess supply
A condition where the quantity demanded of a factor is less than the quantity supplied.
Which of the following causes an increase in desired saving?
A decrease in autonomous consumption.
Milton Friedman's statement
"Inflation is always and everywhere a monetary phenomenon" is accurate in the long run, but not supported by the data for the short run.
If private saving is $616 billion, Japan's government saving is $__________ billion.
264 billion S = Sp + Sg 880b =616b + Sg Sg = 880b - 616b Sg = 264b
Consider the diagram of a small open economy as pictured to the right: When the world real interest rate is 7%, the amount of net exports or capital outflows will be ______ When the world real interest rate is 2%, the amount of net exports or capital outflows will be______
$300 b - Chart $-500b real world interest rate at 2% - Net export is equal to capital outflows
Suppose Japan has a GDP of $3 trillion, and that its national saving rate is 18%. Assume Japan is an open economy If Japan's net exports are 3% of GDP, Japan's investment is $___________ billion. If Japan's imports are $550billion, then Japan's exports will be $__________ billion.
$450b $640b
Types of Supply Shock
1. Technology Shocks - advancements 2. Natural Environment Shocks - blizzards, droughts floods, etc. 3. Energy Shocks - Oil, hydro, etc.
Capital Income Share
= rcK/Y = 0.3Y/Y =0.3
Labor Income Share
= wL/Y = 0.7Y/Y = 0.7
Total Factor Productivity (A) Equation
A = Y / K(.3)L(.7) Y = $10 Trillion K = $10 Trillion L = $100 million Example: A = 10/10(.3)100(.7) A = 10 / (10(.3)100(.7)) A = 0.20 Production function is: Y = 0.20 x (K(.3)L(.7))
In the movie The Count of Monte Cristo (2002) a scene shows the main character paying for an estate in France using a wagon full of silver and gold coins. During the 1800s it was not common for people to pay for a house using this method, but gold and silver pieces were quite extensively used as a mean of payment. What method of payment do you think was most probably used to buy a house, even in the 1800s?
A bank check
National Income
Adding Real labor and capital income together yields Y (= 0.7Y + 0.3Y) = Real Labor Income + Capital Income National income is divided between payments to labor and payments to capital, with the size and quantities of these payments determined by the marginal products of labor and capital.
Suppose Alex earned $1000 (nominal capital gain) from selling stock he bought ten years ago. During the last ten years prices increased significantly, which means that Alex's real capital gain is only $600. If the tax applied to capital gains is 20%, calculate Alex's real after tax capital gain if the tax is applied to his nominal capital gain.
Alex's real after tax capital gain is $400 = 1000 x (20/100) = 200 600-200 = 400
Calculate Alex's real after tax capital gain if the tax is applied to his real capital gain.
Alex's real after tax capital gain is $480. 600 - (.20 x 600) = 480
T-Account
An accounting device used to analyze transactions
velocity of money
Average number of times per year that a dollar is spent or turn over in buying goods and services produced in the economy. concept that provides the link between M and PxY Formula is V = PY/M
It is not unusual to find a business that displays a sign saying "no personal checks, please."
Based on this observation, a checking account must be less liquid than currency.
Which of the following is not a similarity between the effects of changes in domestic saving and investment for large open economies to those for small open economies and closed economies?
Changes in domestic saving and investment will affect the world real interest rate—like small open economies.
What relationship does the aggregate production function portray?
How much output is produced from given quantities of the factors of production.
What is included in the M1 monetary aggregate?
Currency, traveler's checks, demand deposits, and checking account deposits
Productivity
How productive capital and labor are - Variable A
Marginal Product of Capital
MPK = r (c) firms will want an amount of capital that will make the marginal product of capital equal o the real rental price of capital
Marginal Product of Labor
MPL = w firms will hire an amount of labor that will make the marginal product of labor equal to the real wage rate
Assume that you are interested in earning some return on idle balances you usually keep in your checking account and decide to buy some money market mutual fund shares by writing a check.
Everything else the same, M1 will decrease and M2 will stay the same .
Consider a small open economy that is currently running a trade surplus. Assume the graph shown to the right is a representation of desired saving and investment in the small open economy. Based on the current level of the world real interest rate, the real interest rate that would prevail if this were a closed economy is higher than the world real interest rate. Given the decrease in autonomous investment, the trade balance will adjust such that net exports will
False If this country is running a trade surplus, this means that the world real interest rate is such that desired saving exceeds desired investment if this were a closed economy. For this to occur, the world real interest rate must be higher than the domestic closed economy real interest rate. Increase
Suppose the Fed sells $ 300 million worth of government bonds to a bank that pays with part of its reserves held at the Fed. Make the appropriate changes in the Fed's T-account shown below.
Fed System Assets Gov Securities = -300 Liabilities Reserves -300 Bank System Assets Gov. Securities = +300 Reserves = -300
With no change in the desire to borrow by the rest of the world, the change in the domestic economy's lending behavior will cause the real world interest rate to .
INCREASE
What is the effect of an increase in domestic saving on the trade balance and net capital outflows?
If domestic saving increases, net capital outflows will rise and net exports will increase
constant returns to scale
If you increase all the factor inputs by the same percentage, then output increases by exactly the same percentage
How do the conditions required for goods market equilibrium differ in the two types of economies?
In a closed economy, goods market equilibrium occurs when saving equals investment; however, in an open economy, it can still be in equilibrium even when saving and investment are not equal.
Most of the time it is quite difficult to separate the three functions of money. Money performs its three functions at all times, but sometimes we can stress one in particular. For each of the following situations, identify which function of money is emphasized. Brooke accepts money in exchange for performing her daily tasks at her office, since she knows she can use that money to buy goods and services.
In this case, money is being used as a MEDIUM OF EXCHANGE
Maria is currently pregnant. She expects her expenditures to increase in the future and decides to increase the balance in her savings account.
In this case, money is being used as a STORE OF VALUE
Tim wants to calculate the relative value of oranges and apples, and therefore checks the price per pound of each of these goods quoted in currency units.
In this case, money is being used as a UNIT OF ACCOUNT
As real interest rates fall, households and firms are more likely to make investments, and so the desired level of investment in the economy will rise.
Investment
Consider the production function written as Y = F(K,L). In the short run, which of the production function's variables are endogenous and which are exogenous?
K and L are exogenous and Y is endogenous
According to your graph, the domestic economy will now be in a position to lend to the rest of the world.
LESS
During this period,________ grew faster than ___________ and 3-month rates are _____________12-month rates. This implies that the money supply grew_________ in the last part of the year than in the earlier part of the year.
MI M2 smaller THAN MORE SLOWLY
These days many firms post their catalogs or their product prices on the internet. In addition, most retailers have adopted code bars to keep track of their inventories and change prices. Comment on the effect of these technologies on menu costs.
Menu costs are likely to have decreased.
M1
Narrowest measure of money . it includes only the most liquid assets, currency, traveler's checks, demand deposits and checking account deposits
Which of the following is not a determinant of national saving and investment in a closed economy?
Net exports
Currently many banks offer online services that save customers a trip to the bank. In addition, ATMs and debit cards allow depositors 24-hour access to their balances. How have online banking and ATMs changed shoe-leather costs?
Online banking and ATMs have decreased shoe-leather costs.
Two factors that determine the Monetary base
Open market operations discount lending
The revenue of the firm is and the cost is
P X F(K,L) RK + WL
The profit function for a firm can be written as
P xF(K,L) - RK - WL
Inhabitants of Pandora use stone beads as money. On average, every stone bead is used 4 times per year to carry out transactions. The total supply of beads is 50 million. According to the quantity theory of money, the level of aggregate spending in Pandora must be __________ million.
PY = MV PY = 50 x 4 PY = 200
Assume you have saved $20,000 and that you are considering a couple of options. One of them is to use these funds as a down payment to buy a newly built house. The other one is to buy a U.S. savings bond. Which option will add to the economy's capital stock? Buying a newly built house will add to residential investment and therefore add to GDP.
Part A Buying a newly built house will add to residential investment and therefore add to GDP. Part B You should buy the newly built house as a lower real interest rate now means smaller mortgage payments.
What is hyperinflation?
Periods of extremely rapid price increases of more than 50 percent per month
What has been the main cause of hyperinflation episodes?
Rapid growth of the money supply Your answer is correct.
The top portion of the following table lists a variety of monetary factors (or variables), five of which actively determine the economy's money supply. A response box is attached to each factor. Using the labeling key in the table's bottom portion, indicate the five factors that affect the money supply. Do this by identifying the entity(s)long - or player(s) - that exert control over the factor. For those factors that do not affect the money supply use the label (X). HINT: some of the labels are not used and some are used more than once.
Required reserve ratio . FED Borrowed reserves . FED The federal funds rate . X Excess reserves . BD The cost of printing currency . X Currency holdings DEPOSITORS Nonborrowed monetary base . FED B = Banks D = Depositors F = The Fed BD = Banks and depositors BF = Banks and the Fed DF = Depositors and the Fed SEE CHART PAGE 134
Net capital outflow identity
S - I = NX Net Capital Outflow = Trade Balance
Suppose Japan has a GDP of $4 trillion, and that its national saving rate is 22%.
S = Y x s S = 4 x .22 S = .88 trillion S = .88 x 1000 = 880 billion
Now suppose there is an increase in the domestic economy's government expenditure. This increase amounts to a change in the domestic economy's___________ effort.
Saving
What relation between desired saving and desired investment is required for goods market equilibrium?
Saving must be equal to investment
The achievement of equilibrium in the goods market occurs as a result of an adjustment in
THE WORLD REAL INTEREST RATE
Government Policies to Stimulate Saving
Tax Consumption Provide Tax Incentives for Saving Increase Return on Saving Reduce Budget Deficits
Provide Tax Incentives for Saving
Tax-sheltered accounts known as Individual Retirement Accounts (IRAs) to provide households a tax break for depositing money into a savings account. Tax breaks encourages the household to save more, increasing national saving
open market operations
The Fed's buying and selling of bonds in the open market
Federal Open Market Committee (FOMC)
The Federal Reserve committee responsible for open market operations and managing the money supply in the United States. The purchase and sale of government securities that affect both interest rates ad the amount of liquidity in the banking system
What is the significance of the Fisher effect?
The Fisher effect explains the relationship between expected inflation rates and nominal interest rates. the Fisher effect prediction that nominal interest rates rise along with expected inflation is accurate in the long run, but over the shorter time periods, expected inflation and nominal interest rates do not always move together
Irving Fisher wrote book called
The Purchasing Power of Money
budget surplus
The governments tax receipts minus its outlays =government savings T-G
Suppose now that the inhabitants of Pandora use less money to conduct the same number of transactions (i.e., each individual carries fewer beads). 4 times per year 50 million
The velocity of money will increase due to increased number of times the individual will use the beads/money
What is the relationship between velocity and the equation of exchange?
V = P x Y / M
trade deficit
When a country is running a negative balance (NX)
trade surplus
When a country is running a positive NX (trade balance)
What is the Fisher Effect?
When expected inflation rises, nominal interest rates will rise.
What is the Fisher effect?
When expected inflation rises, nominal interest rates will rise.
Which of the following does not represent national saving?
Y - C - I - G
private disposable income
Yd =Y - T private disposable income = GDP, Y - T Net taxes minus gov. transfers minus interest payments on dept.
Does this data support the quantity theory of money?
Yes because money growth and inflation rates are positively correlated.
balance of payments accounts
a bookkeeping system for recording all receipts and payment that have a direct bearing on the movement of funds between a nation (private sector and government) and foreign countries.
Supply shock
a change in the output an economy can produce from the same amount of capital and labor. Involves a change in A - total factor productivity
excess demand
a condition where the quantity demanded of the factor is above the quantity supplied
national wealth
a country's holdings of assets minus its liabilities at a particular point in time.
The monetary base is defined to include the monetary liabilities of the U.S. Treasury (primarily coins) and
currency in circulation. bank reserves. BOTH A & B
As a result of this transaction, the Fed's monetary liabilities
decline by $300 million
The financial crisis that hit the United States first and then the world economy starting in fall 2007 meant that the future prospect of many firms looked gloomy at best for some time. Assuming the goods market is in equilibrium: 1) Using the line drawing tool, graph the new investment curve. 2) Using the point drawing tool, show the new equilibrium real interest rate and level of saving and investment. Given the financial crisis, the level of saving and investment will _________ and the real interest rate will ___________
decrease decrease
private saving (Sp)
disposable income, Y-T, minus consumption expenditure (C) Sp = Y - T - C
classical economists aka classicals
economists who assumed that wages and prices are completely flexible - that is, they completely and quickly adjust to the long-run equilibrium at which supply equals demand
Government Saving
equals net government income less government consumption
private saving
equals private disposable income minus consumption expenditure
M2
includes all of M1 (currency, traveler's checks, demand deposits and checking account deposits) plus less liquid assets money market deposit accounts, money market mutual fund shares with check writing features, savings deposits, certificates of deposits (less than $100,000), time deposits
What is included in the M2 monetary aggregate?
includes all of M1 (currency, traveler's checks, demand deposits and checking account deposits) plus less liquid assets money market deposit accounts, money market mutual fund shares with check writing features, savings deposits, certificates of deposits (less than $100,000), time deposits
Consider the (rather implausible) scenario in which the U.S. government phases out all Social Security transfers to retirees. Assuming the goods market is in equilibrium: 1) Using the line drawing tool, graph the new saving curve. 2) Using the point drawing tool, show the new equilibrium real interest rate and level of saving and investment Given the phase out of Social Security transfers, the level of saving and investment will _______ and the real interest rate will _________.
increase decrease
On March 23, 2010, President Obama signed into law a major overhaul of the U.S. healthcare system. The Congressional Budget Office estimated that this legislation will reduce the U.S. government budget deficit by around $140 billion for the next 10 years. Show the effect of this legislation on the saving curve. Assuming the goods market is in equilibrium: Given the decrease in the U.S. government budget deficit, the level of saving and investment will _______ and the real interest rate will____________
increase decrease
marginal product of capital (MPK)
indicates how much output increases for each additional unit of capital, holding other outputs constant.
Marginal product of labor (MPL)
indicates how much output increases for each additional unit of labor, holding capital constant at $ As the amount of labor input increases, the marginal product of labor declines
classical dichotomy
indicates that in the long run there is a complete separation (dichotomy) between the real side of the economy and the nominal side (which changes with the price level)
Income
is a flow of earnings per unit of time
Net government income
is taxes net of transfers (T) Sg = T - Cg
Revenue from selling goods and services
is the average level of prices of goods and services (P), times the amount of goods and services sold, Y Revenue = P X Y is P x F(K,L)
discount rate
is the interest rate the Fed charges banks for loans
factors of production
labor and capital
large open economies
large countries which are open to trade and capital flows, but are sufficiently large that their saving and investment decisions do influence the world real interest rate.
negative (or adverse) supply shock
lead to a decline in the quantity of output produced from given quantities of capital and labor. Negative shocks are less common, but can occur if burdensome government regulations make the economy less productive. CAUSES THE AGGREGATE PRODUCTION FUNCTION TO SHIFT DOWNWARD AND ALSO CAUSES THE MARGINAL PRODUCTS OF CAPITAL AND LABOR TO FALL