Economics 1015H Exam 2 Study Guide
economic growth (formula)
(% change in nom GDP) - (% change in price level) - (% change in population)
Malthusian Trap
-Malthus's predicted that economic growth increased population growth, rather than per capita income (living standards) The Malthusian Trap, also known as the Malthusian Population Trap, refers to the idea that increased food production as a result of advanced agricultural techniques creates higher population levels. These higher population levels then lead to food shortages, as the new population must live on land that was previously used for crops.
What are the 3 main sources of economic growth? Give ex of each
1. Resources natural: physical land, oil physical capital: means of production human capital: quantity of knowledge within workers more, more output 2. Technology: things created from research and development ex: machinery to produce product more quickly, more consumption 3. Institutions: specific practice, relationship, or organization in society ex. political stability (more investment)
What factors can shift LRAS?
1. permanent change in resources ex. people suddenly all become smarter [SHIFT RIGHT] 2. technology ex. sudden increase [SHIFT RIGHT] 3. institutions ex. increase in stability [SHIFT RIGHT]
Benefits of Economic Growth
1. reduction in 'bad things' like slavery, AIDs, oil spills--more access to knowledge, and technology 2. reduced illiteracy--better access to education, increased life span, better nutrition 3. decreased mortality rate/increased longevity--more access to healthcare, better nutrition
If a nation has GDP growth of 4%, the Price level increases by 1.5% and population increases by 1%, what is the rate of economic growth?
4 - 1.5 - 1 = 1.5%
Why can't we use the argument that AD curve is downward sloping for the same reasons demand curve is downward sloping?
AD curve is the sum of all goods and services and their demand within the economy; 1. WEALTH EFFECT: as price levels rise, you feel poorer in terms of REAL wealth, quantity of real goods and services you can afford declines ex. prices double overnight, can only purchase approx. half what you could yesterday 2. INTEREST RATE EFFECT: if price level rises and real wealth falls, people change their spending habits (save less) ex. less likely to save, lessens Supply of Loanable Funds (Slf shifts to the left) 3. INTERNATIONAL TRADE EFFECT: when price level rises faster than other countries, domestic goods become more expensive than foreign goods ex. more imports, less exports which decreases GDP (Aggregate Qd declines)
Disagreements between Austrian/Keynsian
Austrian: no sticky prices, economy is self-correcting Keynsian: sticky prices, need to steer GDP w/ fiscal and monetary policy and increased govt. spending
Great Recession
Dec 2007-June 2009; Caused by Housing Mkt Bubble; mkt was closely linked to many others in economy--detrimental; poor practices in mortgages, lots of defaulting, banks went out; peak UR: 10%
How is Potential GDP related to Aggregate Supply?
LRAS is centered, inelastically, at potential GDP, and this is what it converges to or back to depending on the changes in the short run aggregate supply/AD
If Real GDP < Potential GDP, how is UR compared to nat rate?
UR is greater than nat rate
How does a small change in the rate of economic growth have a large impact on an economy's income over spans of time?
When taking the Rule of 70 into account, and comparing a country with 1% growth rate versus another with 2% growth, the amount of time it takes to double your money is drastically different. For 1%, it takes 70 years to double, while at 2% it only takes 35--half the time. This small change allows for a much greater increase in income over time for the economy of the first country.
Why can taxes that are too high be harmful for rate of economic growth?
When taxes are too high, it's a disincentive to produce which in turn decreases economic growth. Efficient taxes are taxes sufficient to fund the activities of govt while impeding production/consumption as little as possible.
!!!!Why is Malthus' prediction about population/wages wrong in context with world today?
Women, as they experience increases wages, are less likely to have children Economic growth increases per capita income rather than population growth 1)Industrial Revolution (Increase in commercial productivity and increased opportunities for women) 2) Decline in pop. growth rate when seeing economic growth 3)Child mortality rates declined/ basic healthcare access
Bubble
a market situation in which frenzied demand for an asset pushes the price of that asset far beyond its true economic value
What does alpha represent in the Cobb-Douglas production function?
a value between 0-1 that determines the dependency of the economy on labor/capital
Given the assumption that all savings in Solow model us used in loanable funds mode., what is the relationship between savings rate and interest (rental) rate on capital?
as savings rate increases, interest rate decreases; save more income, which supplies loanable funds which decreases rate(A key component of economic growth is saving and investment. An increase in saving and investment raises the capital stock and thus raises the full-employment national income and product.)
Keynesian Macro
believed in sticky prices; improve recessions thru govt intervention (increased spending); need to steer GDP w/ fiscal and monetary policy [AD]; fails to explain stagflation
Interest Rate Effect
change in price level leads to a change in interest rates, and in the quantity of AD; price level increases, save less and spend less, lower AD and less loanable funds which causes higher interest rate
International Trade Effect
change in price level leads to a change in quantity of net exports demanded; domestic goods more expensive, purchase more exports, NX decreases so AD decreases
Wealth Effect
change in quantity of AD that results from wealth changes due to price-level changes
Monetarist Macro
criticized use of fiscal policy, advocated for monetary policy; assume prices are sticky, but do not rely on them
variable cost
dependent on quantity produced
What did Malthus believe was the driver of population growth?
economic growth and income
Classical Macro
economy is self-correcting; flexible prices; no need for govt regulation, laissez-faire; does not explain why we have recessions
Real Business Cycle Macro
emphasize structural shocks that led to recession that were high predictors of the recession themselves; don't rely on sticky prices as they don't explain gap in UR we see in recession
What type of growth is the Solow Growth model? Why?
exogenous; this is because we assume that consumers are identical, only value working/consumption, and are forced to save x exogenously, as well as all firms being identical
Criticisms of Keynsian in 1970s
fails to explain stagflation (recession w/ high inflation)
crowding out [monetarist]
govt borrowing affects IR and prevents investment
Endogenous growth
growth determined by consumer choices
Exogenous growth
growth in the long term not chosen by agents of the economy
If GDP > Potential GDP, what can we say about the unemployment rate?
if GDP is greater than Potential GDP, then UR is less that the natural rate which means that the economy is overheating (people working too much)
Why does a change in depreciation rate of capital change the steady state level of capital?
increase in depreciation rate, decrease in steady state; if there is a change in depreciation rate of capital, this changes the slope of the depreciation curve (steepens/flattens). Because of this, where the depreciation curve intersects the savings curve will change dependent on the shift, and, resultingly, the steady state level of capital will shift accordingly
In the short run, an increase in the price level does what to the quantity of AS?
increases it; due to relationship between sticky input prices and flexible output prices
fixed cost
independent of quantity produced
what is equal in solow at SS
k t plus 1 = k t skt^1/3 = deltakt
Given LOMOC, what is relationship between depreciation rate and savings rate in the steady state? Derive as equation and explain
kt+1 = (1 - delta)kt + skt^1/3 if you have k today, (1-delta) will still be there tomorrow and if you save sy (sk^1/3) today, then firms will use that as investment to produce capital tomorrow. so, k tomorrow is equal to the sum of the capital today that has not be depreciated, and the savings of today that will be invested in tomorrow
Potential GDP
level of Real GDP if the economy were functioning as well as it possibly could (y star)
mortgage backed security
lumped mortgages that decreased risk/effect of defaulting SECURITAZATION
What effect did Smoot-Hawley tariff act have on Great Depression?
made it worse w/ trade war, less net exports/GDP RETALIATION
Housing Market Bubble
main cause of recession; housing prices increased past true value, greater incentive to take risks; burst because of lumped mortgages (Mortgage back security) Ninja loans/subprime loans/adjustable rate mortgages; expectations decreased, defaulting, banks failed
Ricardian Equivalence [monetarist]
more govt spending, people save more because of expected increased tax rates
Ninja loan
no income, no job, no assets
Will profit ever be non-zero, according to solow?
no, because we are assuming a perfectly competitive model for the economy, and from the firm's profit function, revenue is completely used on wages and investment on capital
Would banning wage contracts for workers eliminate price stickiness?
no, it would only reduce them can never fully eliminate sticky prices
!!!!!!Why does population growth rate decline rapidly after an economy is lifted out of extreme poverty?
once out of extreme poverty, they have access to the bare minimum healthcare, but infant mortality rate does decline; less incentive to have kids since there is less chance they will pass young
Great Depression
peak UR: 25%; -7.46% Real GDP from 1929-1933; Caused by Stock Mkt Bubble and poor macroeconomic policy; people bought stocks on margin, lots of debt, govt decreased quantity of money by 1/3; banks went out as withdrawals increased rapidly; Fiscal policy raised taxes and Smoot-Hawley Tariff act
In steady state, S = alpha what does this mean?
people are consuming wage income and saving capital income
What happens when a bubble bursts?
prices decline because expectations have decreases, detrimental to economy if the bubble is involved in a market that is connected to other markets
Why was Smoot-Hawley put in place?
protect american jobs/industries
economic growth
rate of real GDP per capita growth over time (changes in standard of living)
What savings rate maximizes consumption?
slope of y (k^1/3) is equal to slope of depreciation SOCIAL PLANNER, determine consumption best for consumer
Sticky Price Effect
some input prices are fixed in SR, then firms will change quantity produce in response to greater revenues and the same costs (max profit) WHY SRAS IS UPWARD SLOPING
Sticky Wage Effect
some wages are determined by contract, so in the SR wages may not move w/ price level WHY SRAS IS UPWARD SLOPING
!!What was the onset for the Great Depression?
stock market bubble burst w/ faulty macroeconomic policy; occur at the beginning because they trigger the effects of a depression/recession
What do monetarists advocate for?
strong monetary policy to steer economy; criticized fiscal policy
!!!!Emphasis of Real Business Cycle
structural shocks that lead to recessions (especially on the supply side) that predict the recession rather than what occurs during; assume sticky prices, but do not rely on them to explain gap in UR
Suppose over a period of 20 years, Real GDP per capita for a country rose from $600 to $800. Find economic growth.
the 20th square root of (800/600) minus 1 = .014%
Why do economies converge to a steady state level of capital, income and consumption that is the same level, given enough time?
they do not, the parameters vary between economies, so they will not converge to the same income
Why was housing market bubble worse than tulip bubble?
tulip market wasn't involved with other markets in the economy
annualized average growth rate
value @ time t = initial value(1 + growth rate)^t
Why do open and competitive markets help foster economic growth?
with little to no barriers to entry, profits are the incentive to enter market, and it is easy to do. this fosters the most production/innovation at the lowest prices for consumers; more output, more economic growth
Does UR peak at the end of a recession?
yes, because they have just hit the lowest point of GDP
Do monetarists believe in sticky prices?
yes, but this isn't what should be relied on MONETARY POLICY
