MACRO #2

an asset that can be easily and quickly converted to money without loss of value

Liquid Asset

economists who believe that there are strong forces pushing a market economy toward full-employment equilibrium and that macroeconomic policy is an ineffective tool with which to reduce economic instability

New Classical Economists

interest-earning deposits that are also available for checking

Other Checkable Deposits

A certificate of ownership in a corporation

Stock

Keynes rejects the view that lower wages and interest rates will get the economy back on track. He believes that wages and prices are highly inflexible. He also rejects the idea of lowering interest rates to get the economy back on track. He believes that when people are pessimistic about the future, lower interest rates will fail because people will continue to refrain from spending.

3. What does Keynes reject about the Classical macroeconomic model? How does this lead Keynes to view the economy as inherently unstable?

LRAS curve = relationship between output and price levels Shift Right: economic growth Shift Left: decrease in wealth, or IR, or expectations, or inflation, or incomes abroad, or exchange rates

3. What is the meaning of the long run aggregate supply curve and what causes it to shift.

The Keynesian multiplier is the concept that an increase in spending will result in an increase in total income. It builds on the idea that one person's expenditures becomes the income of another. The Expenditure multiplier is the ratio of the change in equilibrium output to the independent change in investment, consumption, or government spending that brings about the change. Basically, however much the initial amount increases by is the expenditure multiplier.

4. What is the Keynesian multiplier? What is the Expenditure multiplier?

It is the relationship between a nation's price level and the quantity of goods supplied by its producers in the short run. The SRAS may shift from changes in resource prices, changes in the expected rate of inflation, and supply shock.

4. What is the meaning of the SRAS curve and what causes it to shift?

Increases = economic booms / unemployment is very low Reductions = low output / high rates of unemployment

6. What is the effect of unanticipated changes in AD and AS?

Housings prices fell, mortgage default rates and housing foreclosures started to rise. The construction industry contracted sharply. As a result people became pessimistic about the economy which created a further reduction in AD. Then US stocks plummeted and the recession then spread to other countries and the falling incomes abroad depressed AD even more. Also, gas prices soared

7. What caused the economic conditions to deteriorate so rapidly in 2008?

a situation in which total government spending exceeds total government revenue during a specific time period, usually one year.

Budget Deficit

a situation in which current government revenue from taxes, fees, and other sources is just equal to current government expenditures

Balanced Budget

Currency appreciation means one of the currencies is now worth more in relation to the other than it was before the exchange. The currency depreciation is the opposite.

Currency appreciation vs depreciation

a change, in laws or appropriation levels, that alters government revenues and/or expenditures

Discretionary Fiscal Policy

The curve shows the relationship between the price level and the real GDP. It has a downward slope because of the purchasing power of money, the nominal interest rate, and relative prices of domestic goods vs foreign goods

Explain what the AD curve is and why it is downward sloping.

Government taxation and spending

Fiscal Policy

A market in which all the different sectors of the market are operating in equilibrium.

General equilibrium market

It is where the amount demanded is brought into balance with the amount supplied in the aggregate-resource market. This determines the level of output in the goods and services market because it shows what people are willing to pay for a certain amount of goods supplied.

How does the equilibrium in the resource markets determine the level of output in the goods and services market?

The output of one factory that are used by another business.

Intermediate Goods

The loanable funds market is used to describe the market that coordinates the borrowing and lending decisions of business firms and households

Loanable funds market

the sum of (1) currency in circulation (including coins), (2) checkable deposits maintained in depository institutions, and (3) traveler's checks

M1 (money supply)

equal to M1 plus (1) savings deposits, (2) time deposits (accounts of less than $100,000) held in depository institutions, and (3) money market mutual fund shares.

M2 (money supply)

additional current consumption divided by additional current disposable income

Marginal Propensity to Consume (MPC)

Market equilibrium means that the forces exerted by buyers and sellers balance one another. They are both satisfied with where they are. Full employment equilibrium is the level at net national income where everyone who wants to be employed is; there is sufficient demand to employ everyone.

Market equ. vs. full employment equ.

an asset that is used to buy and sell goods or services

Medium of Exchange

The control of money supply

Monetary Policy

interest-earning accounts that pool depositors' funds and invest them in highly liquid short-term securities. Because these securities can be quickly converted to cash, depositors are permitted to write checks (which reduce their share holdings) against their accounts.

Money Market Mutual Funds

the concept that an increase in spending on a project will generate income for the resource suppliers, who will then increase their consumption spending. In turn, their additional consumption will generate income for others and lead to still more consumption. As this process goes through successive rounds, total income will expand by a multiple of the initial increase in spending.

Multiplier Principle

includes the labor market, raw materials, and physical capital. In this market, income is mostly used to buy goods and services.

Resource market

a reduction in government expenditures and/or an increase in tax rates such that the expected size of the budget deficit declines (or the budget surplus increases)

Restrictive Fiscal Policy

the view that a tax reduction financed with government debt will exert no effect on current consumption and aggregate demand because people will fully recognize the higher future taxes implied by the additional debt

Ricardian Equivalence

financial institutions that accept deposits in exchange for shares that pay dividends. Historically, these funds were channeled into residential mortgage loans, but today they offer essentially the same services as a commercial bank.

Savings and Loans Associations

At equillibrium=all savings are invested... "if a person does not spend all of their income, the economy suffers from lack of cash flow... if all savings are invested, the economy stays at Full Employment because that invested money gets borrowed by others."

Say's Law

Stores buy it, make money, pay for the loan with money made

Self-liquidating Loan

Matching the maturity of income generating assets with the maturity of interest incurring liabilities.

The principle of matching maturities

Money that one has now can be spent today, but money that someone does not have, cannot be spent now...this is when someone would borrow

Time Rate of Preference

a unit of measurement used by people to post prices and keep track of revenues and costs

Unit of Account

this is a diagram that is used to represent the monetary transactions in an economy

What is the Circular Flow Model?

1. A change in output affects the economy and has a role in macroeconomics adjustment policies not just a change in price. 2. Results of change in AD depend on where we are relative to full employment. AD fluctuations make economy unstable. 3. Market forces may fail to restore full employment quickly. The responsiveness of AS to changes in demand will be directly related to idle resources. If there are idle resources, output will be highly responsive to changes in AD. 4. Keynesians believe that it is important for there to be policy designed to counter fluctuations in AD

What is the Keynesian model? Tell all that you know about it...

the Keynesian multiplier is the concept that an increase in spending will result in an increase in total income. It builds on the idea that one person's expenditures becomes the income of another. The Expenditure multiplier is the ratio of the change in equilibrium output to the independent change in investment, consumption, or government spending that brings about the change. Basically, however much the initial amount increases by is the expenditure multiplier.

What is the Keynesian multiplier? What is the Expenditure multiplier?

the consumption function says that consumption is a function of income. Thus, if a person has more income they will consume more and thus increase demand. If their income decreases they will consume less, thus decreasing demand. This idea led to Keynes' belief in demand side economics, in which demand determines the level of economic activity. If a person has more money, they will buy (demand) more things

What is the consumption function? How does that lead to the Keynesian view that demand determines the level of economic activity?

curve showing the relationship between a nation's price level and the quantity of goods supplied by its producers

aggregate supply curve

the demand based on the price of wages

derived demand

Actual Inflation GREATER = borrowers do better ; Actual Inflation LESS = lenders do better

how does inflation affect borrowers and lenders?

Nominal (money) is the money rate, real is adjusted for inflation Nominal (money) = real + inflation Real IR is more accurate because it accounts for Inflation

nomical interest rate vs. real interest rate

the supply of the business needs to be at the demand of the product people are willing to purchase

resource market at equilibrium?

The market encompasses all resources contributing to the production of current output. it is the largest portion of the whole market.

role of the resource market?

In the short run, it is an upward sloping curve,but in the long run the aggregate supply curve is vertical.The short run aggregate supply curve shows the various quantities of goods and services domestic firms will supply in response to changing demand conditions that alter the level of prices in the goods and services market. The long run aggregate supply curve shows the relationship between price level and quantity of output after decision makers have had time to adjust their prior commitments, or take steps to counterbalance them, when the price level changes. In the short run, firms will generally expand output as the price level increases; the higher prices will improve their profit margins because many of their cost components will temporarily be fixed as the result of prior long term commitments. However, once people have had time to adjust their prior long-term commitments, resource markets will adjust to higher levels of prices and will no longer have an incentive to supply a larger output at the higher price level.

short-run vs. Long-run aggregate supply curve

determines the rate that two countries currencies are exchanged at

the foreign exchange market

contains household expenditures, business investment, govt purchases, and net exports. It is a very diverse market

the goods and services market

PIH says that people have 2 different types of income: permanent and transitory. Permanent income is reliable and is more likely to be used for consumption. Transitory income is income that is temporary and is usually used to pay down debt or be saved (notes).

1. What is the Permanent Income Hypothesis (PIH)? What are the differences in the two types of income?

Created the Tableaux Economique -The Flow of goods and incomes throughout the economy

1756- F. Quesnay

Wealth, IR, Expectations, Expected Inflation, Abroad Income, Exchange Rates

2. What Factors might cause the AD to shift?

Supply shock is an event that suddenly increases or decreases the supply of a good or service. Due to the nature of supply shock there is no Long Run effect. Supply shock only affects transitory income and not permanent income

5. What is a supply shock? What is the LR effect of a SS?

1. By the personal income Hypothesis consumption remains fairly stable in the economy. 2. Raw material prices drop in a recession and investing becomes more profitable. 3. Interest rates fluctuate over the cycle and as IR drop people invest more in expectation of expansion (p.

6. How does the economy correct itself in the long run?

Imports - Exports = Capital inflow - Capital outflow When the exchange rate is determined by market forces, trade deficits will be closely linked with an inflow of capital. In contrast, trade surpluses will be closely linked with an outflow of capital.

9. Define imports, exports, capital outflow and inflow and explain their relationship?

built-in features that tend automatically to promote a budget deficit during a recession and a budget surplus during an inflationary boom, even without a change in policy

Automatic Stabilizers

vault cash plus deposits of banks with Federal Reserve banks

Bank Reserves

Debt.. a person lends a company money

Bond

a situation in which total government spending is less than total government revenue during a time period, usually a year.

Budget Surplus

Determined by the workforce (Supply and demand)

Labor Market

an institution that regulates the banking system and controls the money supply

Central Bank

Taxes= Govt spending Savings=Investment Imports=Exports

Classical Model

Holds deposits and makes loans

Commercial Banks

financial institutions that offer a wide range of services (for example, checking accounts, savings accounts, and loans) to their customers. Commercial banks are owned by stockholders and seek to operate at a profit.

Commercial Banks

"The 90 day note" Stores borrow money for inventory

Commercial Loans

Crowding out effect states that trying to stimulate the economy through government deficit doesn't work because it raises interest rates and thus decreases investments. ILF analysis says government borrowing to stimulate the economy raises interest rates which increases foreign investment, which decreases domestic production and the capital inflow causes a trade deficit. Both of them use rising IR to show flaws in fiscal policy that uses deficits.

Compare and contrast the crowding out effect and the international loanable funds (ILF) market analysis.

a policy that tends to move the economy in an opposite direction from the forces of the business cycle. Such a policy would stimulate demand during the contraction phase of the business cycle and restrain demand during the expansion phase.

Countercyclical Policy

funds acquired by borrowing

Credit

Created for hourly employees Lower rates of interest A financial institution owned by its members that provides many of the same services as a bank.

Credit Union

financial cooperative organizations of individuals with a common affiliation (such as an employer or a labor union). They accept deposits, including checkable deposits, pay interest (or dividends) on them out of earnings, and lend funds primarily to members.

Credit Unions

a reduction in private spending as a result of higher interest rates generated by budget deficits that are financed by borrowing in the private loanable funds market

Crowding-Out Effect

medium of exchange made of metal or paper

Currency

non-interest-earning checking deposits that can be either withdrawn or made payable on demand to a third part. Like currency, these deposits are widely used as a means of payment.

Demand Deposits

businesses that accept checking and savings deposits and use a portion of them to extend loans and make investments. Banks, savings and loan associations, and credit unions are examples

Depository Institutions

Keynesian -- an increase in government spending and/or a reduction in taxes will be magnified by the multiplier process and leads to a substantial increase in AD. When an economy is operating below capacity, real output and employment will also increase substantially and there will not be inflation. Crowding Out -- expansionary fiscal policy will exert little or no effect on AD and employment because borrowing to finance the budget deficit will push up interest rates and crowd out private spending and investment. In an open economy, the higher interest rate will attract an inflow of spending and investment. In an open economy, the higher interest rate will attract an inflow of foreign capital, which will moderate the increase in interest rates, but it will also cause the dollar to appreciate. In turn, the appreciation of the dollar will reduce both net exports and AD. New Classical -- believe that there are strong forces pushing a market economy toward FE equilibrium and that macroeconomic policy is an ineffective tool with which to reduce economic instability. In their opinion expansionary FP will exert little or no effect on AD and employment because households will anticipate the higher future taxes that might result from the debt and reduce their spending and increase saving in order to pay them. Like current taxes, debt will lower private consumption because of the preparation for future taxes. Supply Side -- believe that changes in marginal tax rates exert important effects on the AS. Lower marginal tax rates will increase the motivation to earn and improve the efficiency of resource use which leads to an increase in real output in the long run.

Describe the four basic economic views -- Keynesian, Crowding out, New Classical, and the Supply side view

Leakages include the fact that households will use some of their income to purchase imports, some of the income will be taxed away by the government, and some of it will be saved. Injections include investment expenditures, government purchases, and exports. Equilibrium in the injections-leakages model relies on a balance between the injections into the core circular flow and leakages out of the flow

Discuss the various leakages and injections from the circular flow of income.

DFP is when the government makes deliberate changes in the level of government spending and taxes for the purpose of stabilizing the economy. DFP takes too much time to be put into action and therefore susceptible to lag. AFP is more effective because it allows the government to respond to economic fluctuations quickly. AFP includes progressive income tax rate, corporate income tax, and unemployment compensation.

Distinguish between discretionary fiscal policy (DFP) and automatic fiscal policy (AFP)

the AE model looks at nominal income and has the polar assumption of SRAS being horizontal until full employment is reached and then it becomes vertical. It can't account for inflation, whereas with the AS-AD model we can see the inflation that can result in shifts in AS and AD. The AD-AS model is a more realistic view. The AS-AD model looks at the real output and price levels.

Distinguish between the AS-AD model and the Aggregate Expenditures model. What are the limitations of the AE model that are remedied when we make use of the AS-AD model?

an increase in government expenditures and/or a reduction in tax rates, such that the expected size of the budget deficit expands

Expansionary Fiscal Policy

the ratio of the change in equilibrium output to the independent change in investment, consumption, or government spending that brings about the change. Numerically, the multiplier is equal to 1 divided by (1-MPC) when the price level is constant.

Expenditure Multiplier

the Keynesian Paradox of Thrift states that when everyone plans to save money, people stop buying stuff. When people stop buy stuff, other people stop making money because they are not selling things. Then, the people who wanted to save in the first place cannot save.

Explain the Keynesian Paradox of Thrift

because AE focuses on the demand side of the economy by explaining how each equilibrium through the way people spend money. Thus, the AE model is more in line with Keynesian model.

Explain why the Aggregate Expenditures model is better suited for the Keynesian model than the Classical model.

the central bank of the US; it carries out banking regulatory policies and is responsible for the conduct of monetary policy

Federal Reserve System

money that has neither intrinsic value nor the backing of a commodity with intrinsic value; paper currency is an example

Fiat Money

person puts money into this policy in case of an event such as death

Life Insurance

Commercial Banks Savings and loans Credit Union Insurance Companies Stock and Bond markets Commodity market Derivatives

Financial Institutions

a system that permits banks to hold reserves of less than 100 percent against their deposits

Fractional Reserve Banking

the Keynesian perspective indicates that this will stimulate recovery and generate strong growth. Non-Keynesians believe that this policy will lead to a sluggish recovery and slow future growth.

How do Keynesians and non-Keynesians differ over the Great Experiment of large increases in federal spending and budget deficits of US policies makers trying to get us out of the recession of 2008?

In a flexible exchange system, an exchange rate is set by the market demand and supply by each currency being traded. Imports-exports= capital inflow- capital outflow. When imports exceed exports there is a trade deficit. When the opposite is true, there is a trade surplus. When the exchange rate is determined by market forces, trade deficits will be closely linked with an inflow of capital. In contract, trade surpluses will be closely linked with an outflow of capital.

In a flexible exchange system [i.e. one where market forces of supply and demand determine the exchange rate], how is the exchange rate set? What is the importance of the foreign exchange market for keeping the overall economy at full employment? Explain, showing how the exchange rate is tied to trade deficits and trade surpluses.

Taxes+Savings+Imports = Govt Spending+Investments+Exports

Keynesians Model

the idea that when many households simultaneously try to increase their saving, actual saving may fail to increase because the reduction in consumption and aggregate demand will reduce income and employment

Paradox of Thrift

Person puts money into this policy in case of damage to property such as house fire or car accident

Property and Casualty

the minimum amount of reserves that a bank is required by law to keep on hand to back up its deposits. If reserve requirements were 15%, banks would be required to keep $150,000 in reserves against each $1 million of deposits.

Required Reserves

Includes labor market, raw materials, and physical capital. -Demand and supply determine prices.

Resources Market

an asset that will allow people to transfer purchasing power from one period to the next

Store of Value

economists who believe that changes in marginal tax rates exert important effects on aggregate supply

Supply-Side Economists

1. Proper timing of discretionary fiscal policy is both difficult to achieve and crucially important 2. Automatic stabilizers institute fiscal policy without timing issues 3. Fiscal policy is much less potent than the early Keynesian view implied

What are areas of agreement about Fiscal Policy as a stabilizer between Keynesians and non-Keynesians?

Resource market Goods and services market loanable funds market foreign exchange market

What are the 4 economic markets?

Keynesian -- (horizontal) increasing how much is produced will not lead to inflation - The economy is likely to be in a recession or depression - Prices are fixed Intermediate -- changing aggregate demand by increasing fiscal policies (increasing purchases or cutting taxes) will improve the economy. - Prices are increasing and supply is increasing Classical -- as aggregate demand keeps increasing, prices increase and the limit of output is reached. - Prices increase but supply is close to the same

What are the differences between the Keynesian Range, the Classical Range, and the Intermediate Range?

1. A tax cut will generally stimulate AD faster 2. A tax cut is less likely to increase structural unemployment and reduce the productivity of resources. 3. A tax cut is easier to reverse once the economy has recovered 4. A reduction in tax rates will increase the incentive to earn, invest, produce, and employ others stimulate aggregate demand quickly, unlikely to increase unemployment, easy to reverse later on, increases the incentive to earn and invest.

What are the four main reasons why a tax cut is likely to be more effective than a spending increase to promote economic recovery and long-term growth?

RFP would be deliberate changes in government spending or taxes to counter an expansion. Policies that would be consistent would be a decrease in federal spending or an increase in taxes. While it could be effective to help balance the economy, RFP is rarely used because it is not beneficial to politicians. And Keynes argues that the government needs to be continually injecting into the economy.

What does Keynes mean by restrictive fiscal policy? What types of government policies would be consistent with a restrictive fiscal policy? When would it be used?

Keynes rejects the view that lower wages and interest rates will get the economy back on track. He believes that wages and prices are highly inflexible. He also rejects the idea of lowering interest rates to get the economy back on track. He believes that when people are pressimistic about the future, lower interest rates will fail because people will continue to refrain from spending.

What does Keynes reject about the Classical macroeconomic model? How does this lead Keynes to view the economy as inherently unstable?

Economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the (equilibrium) values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal.

What does it mean to say that the economy is at equilibrium?

The exchange rate at which the demand for a currency and supply of the same currency are equal. The equilibrium exchange rate indicates that the price of exchanging two currencies will remain stable.

What is meant by the equilibrium exchange rate?

the LC is an upside down U with government revenue being on the y axis and tax rate being on the x axis. says that as tax rates are increased, rate increases will increase the revenue from the tax. Eventually, however, higher and higher rates will lead to a maximum revenue point, and tax rate increases beyond this level will actually reduce the revenue collected.

What is the Laffer curve? What are its implications for tax policy?

it doesn't matter if the government raises taxes or borrows money they both have the same effect. If the government raises taxes, people will spend less and the economy slows down. If the government increases its spending, the tax interest rate increases so savings are increased and consumption goes down, which also slows down the economy.

What is the Ricardian Equivalence Theorem? What implications does it have for fiscal policy?

The classical school says achieving full employment at capacity should be from supply side and that the economy will fix itself after a while. Keynesians believe it should be from the demand side and that changes in output created by the government rather than changes in prices direct the economy toward equilibrium

What is the difference between the Classical school and the Keynesian school of economics regarding economic stability?

the classical school says achieving full employment at capacity should be from supply side and that the economy will fix itself after a while. Keynesians believe it should be from the demand side and that the changes in output created by the government rather than changes in prices direct the economy toward equilibrium.

What is the difference between the Classical school and the Keynesian school of economics regarding economic stability?

When the three curves intersect at a common point, two things are true... 1)any time that the Aggregate demand and the Short run aggregate supply(SRAS) intersect, the economy is at equilibrium. 2) when this market equilibrium coincides with the LRAS, the economy is also at full employment.

What is the significance of the triple point, i.e. where the three curves simultaneously intersect? (supply curve)

If market equilibrium below full employment equilibrium we are in a recession. If the opposite is true we are in an expansion or a time of good economic value.

What is true about the economy if the market equilibrium is either above or below the full-employment equilibrium

1. An increase in government spending will increase aggregate demand 2. A reduction in personal taxes will increase the income of households (this is what expansionary fiscal policy is)

Why should we have fiscal policy according to Keynes?