EXAM 3. Macroeconomics

Captial Stock

(A sub of physical capital.) Capital stock is, the plant, equipment, and other assets that help with production.

Monetary policy

(Federal Reserve). fed controlling the money supply in the economy, thru open market policies. fed buys bonds to increase money in the economy. fed sells bonds to decrease money in the economy.

Automatic stabilizers (fiscal policy)

(Fiscal policy = Gov/white house.) Automatic stabilizers are created with the goal to stabilize income levels, consumption patterns or demand, business spending, and get automatically triggered-without specific authorization. EXAMPLES: include progressively graduated personal and corporate income taxes, as well as unemployment insurance, welfare, stimulus checks.

Nominal GDP Calculated

(Nominal GDP is not effected by inflation, only Real GDP is ) Nominal GDP calculated by, GDP= C + I + G + (X-M) C= private consumption I= Gross investment G= Government Investment X = Exports M =imports. Example: If a country reports $5 trillion in private consumption, $10 trillion in gross investment, $4 trillion in government investment, exported $2 trillion of goods and imported $1 trillion, its nominal GDP would be: GDP= 5 + 10 + 4 + (2-1) = 20 aka, 20 trillion.

Fiscal Policy (ch.21)

(white house/ government) The use of government spending and taxation to influence the economy.

Spending Multiplier

1/ (1-savings.) so if our households spend 0.80 and save 0.20 of their 1$ dollar income. (1/(1-

multiplier effect

1/(1-MPC). to find MPC = 1/ spending. MPC= income, and savings, and spending.

Which of the following would lead to a shift in the short-run aggregate supply curve but no change in the long-run aggregate supply curve?

A decrease in the expected price level. EX: The long-run aggregate supply curve is affected by labor, capital, natural resources, and levels of technology. & And whatever effects long-run affects short run and vis versa.

Deficits

A deficit occurs when expenses exceed revenues, imports exceed exports, or liabilities exceed assets in a particular year. Governments and businesses sometimes run deficits deliberately, to stimulate an economy during a recession or to foster future growth.

Money neutrality suggests that an increase in the money supply leads to _____ in price level and inflation and _____ in real GDP.

A increase, No change. "M * V = P *Y", with all the others being equal, if M (money supply) increases, then P (price level) also increases. Money neutrality states that the changes in the money supply only affect nominal GDP, not real GDP.

An earthquake destroys capital stock in an economy. The result is

A leftward shift in the long-run aggregate supply curve. EXPLANATION: Since the capital stock decreases, it only affects the long-run aggregate supply curve. If it decreases, then the LSAS curve would shift to the left.

Which of the following would not lead to a decrease in aggregate demand and a leftward shift in the AD curve?

An increase in domestic price level. EX: The change in the price doesn't shift the aggregate demand curve; instead, it causes movement along the curve.

Which of the following shifts both the short-run and long-run aggregate supply right?

An increase in the capital stock EX: The expected price level only has an impact on the short-run supply curve. And, the actual price level only affects the aggregate demand curve.

If the economy is producing below the natural rate of output in the short-run, wages and input prices will eventually ____ and ____ will increase, returning the economy to long-run equilibrium.

Fall / short-run aggregate supply. EX: Draw the graph of the aggregate demand, SRAS, and LRAS curve to see the situation. If the economy is producing below the natural level of output, then the SRAS curve has to shift to the right to reach an equilibrium point.

Other things the same, when the price level falls, interest rates

Fall, so firms increase investment. EX: The price level and the interest rates are in positive correlation, which means if the price level falls, then the interest rate also falls. The interest rate is closely related to investment (refer to the handout). So, if the interest rate falls, then the firms can borrow more money with less interest. Thus, the investment increases.

Real GDP calculated (explanation/ definition)

First Step, to calculate real GDP, we discount the nominal GDP by a GDP deflator. GDP deflator = A measurement of the price level of new goods and services available in a country's domestic market. which includes, prices for businesses, the government, and private consumers. The GDP deflator essentially removes inflation from the equation.

Which of the following would lead to a decrease in the multiplier effect of fiscal policy?

Households save a higher fraction of income. The multiplier effect of the fiscal policy is calculated as 1/(1-MPC). So, if the household saves a higher fraction of the income, then the income the consumers spend would be less. Thus, the multiplier effect of the fiscal policy would decrease. so if households spend more, the MPC would increase.

Housing's influence on aggregate demand.

If House prices rise, then the wealth effect is likely to cause an increase in consumer spending. This will cause higher Aggregate Demand (AD), and it is likely to cause an increase in Real GDP and a higher rate of economic growth. ( wealth effect) (ch.20)

inflation higher than expected what happens to interest rate

Inflation reduces the value of money. Because of that, people who have borrowed money benefit from a higher inflation rate when they pay the money back. The interest rate that a borrower pays is effectively lower thanks to inflation.

The inflation tax

Is an alternative to income taxes and government borrowing. & is the revenue created when the government prints money. & is like a tax on everyone who holds money. EX: The inflation tax is the revenue the government raises by creating (printing) money. It is like a tax on everyone who holds money (when the government prints money).

M * V = P *Y, Quantity Equation (Quantity theory of money)(ch.17) (Money Neutrality).

M (money supply) P (price level) V (velocity of money) Y (Real GDP) (growth rate of the money supply + growth rate of the velocity of money )= ( inflation rate + growth rate of output.) M * V = P *Y

The Federal Reserve controls _____ and influences ______ with the intention of influencing ____ .

Money supply/ interest rate/ investments he Federal Reserve would use open market operation (four methods) to control the money supply. By controlling the money supply, the price level and aggregate demand are affected. Consequently, it influences the interest rate. We know that the interest rate is closely related to investments.

The sticky-wage theory of the short-run aggregate supply curve says that when the price level rises more than expected,

Production is more profitable and employment rises. If P is greater than the expected price (PE), then the production is more profitable, so the firms increase output and employment.

Real GDP calculated

Real GDP ( base year $)= Nominal GDP * ( real GDP base year)/ (real GDP current year).

Potential GDP & Real GDP

Real GDP is the value of the output during a period; it may be one quarter or one year. It is otherwise referred to as actual GDP, Potential GDP refers to the level of output that a nation's economy can produce at a constant inflation rate.

Relative-price variability

Rises with inflation, leading to a misallocation of resources. Relative price variability is in positive correlation with inflation. & , the relative-price variability leads to the misallocation of resources.

In order to understand how the economy works in the short run, we need to

Study a model in which real and nominal variables interact. ( the aggregate supply and aggregate Demand curve?)

Which of the following accounts for about two-thirds of the decline in output during a recession?

The decline in investment spending. During the recession, the decrease in firms' total investment spending accounts for the most decline in output in the economy.

Which of the following would be classified as fiscal policy?

The federal government cuts taxes to stimulate the economy. EX: The fiscal policy is defined as the use of government spending and TAX policies to influence economic conditions.

Crowding Out effect

The offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending.

This question is equivalent to three questions. Partial credit is awarded. Select the correct answers from the drop-down menu. Suppose the tax rate on nominal interest income is 20% and does not change over time. Also assume the real interest rate remains constant. In year 1, the inflation rate is 4% and the nominal interest rate is 10%. In year 2, the inflation rate is 14%. The real interest rate in both years is: The nominal interest rate in year 2 is: The after-tax nominal interest rate in year 1 is: The after-tax nominal interest rate in year 2 is: The after-tax real interest rate in year 1 is: The after-tax real interest rate in year 2 is:

The real interest rate in both years is: 6 The nominal interest rate in year 2 is: 20 The after-tax nominal interest rate in year 1 is: 8 The after-tax nominal interest rate in year 2 is: 16 The after-tax real interest rate in year 1 is: 4 The after-tax real interest rate in year 2 is: 6 EXPLANATION: *nominal interest rate - inflation rate = real interest rate *After-tax nominal interest rate - inflation rate = after-tax real interest rate For W - the real interest rate is calculated as subtract the inflation rate from the nominal interest rate. (10%-4%=6%) For X, - the nominal interest in year 2 is calculated as add the inflation rate to the real interest rate we arrived at for W. (14%+6%=20%) For Y, - the after-tax nominal interest rate in year 1 is calculated as 10%*(1-20% (of the tax rate) = 8%). For Z, - the after-tax nominal interest rate in year 2 is calculated as 20%*(1-20%)=16% For A, - the after-tax real interest rate in year 1 is calculated as the after-tax nominal interest 8% - inflation rate of 4% = 4% For B, -the after-tax real interest rate in year 2 is calculated as 16%-14%=2%

Real GDP and Unemployment Rate

They are a combined relationship. if GDP grows rapidly the unemployment rate declines, if growth is very low or negative the unemployment rate rises, and if growth equals potential the unemployment rate remains unchanged. (potential GDP & Real GDP are intertwined)

In the short-run, an increase in aggregate supply leads to _____ price level and _____ in unemployment.

a decrease / a decrease The aggregate supply curve and the price level are in a negative correlation, which means if the SRAS curve has an increase, then the price level decreases. If the price level decreases, then people can buy more things with the money they have. Thus, unemployment also decreases.

nominal interest income.

also called nominal intrest rate. = The nominal interest rate (or money interest rate) is the percentage increase in money you pay the lender for the use of the money you borrowed. For instance, imagine that you borrowed $100 from your bank one year ago at 8% interest on your loan.

Which of the following policy actions shifts the aggregate-demand curve?

an increase in government spending an increase in taxes an increase in the money supply The four factors that shift the aggregate demand curve are: Changes in C (consumer spending), changes in I (investment), changes in G (government spending), and changes in NX (net exports).

Which of the following shifts both the short-run and long-run aggregate supply right?

an increase in the capital stock The expected price level only has an impact on the short-run supply curve. And, the actual price level only affects the aggregate demand curve.

In the long-run,

an increase in the price level has no effect on the aggregate quantity of GDP supplied. EXPLANATION: the situation is in the long run, so the change in the price level only has an impact on the short run. Thus, the right option is that it would have no effect on the aggregate quantity of GDP supplied.

Creditors

banks that lead out money. or a person who loans somone money.

Relative-price variability definition

changes is related to changes in real income, to real factors on the supply side, and to a measure of "surprise," that is, the difference between actual and anticipated rate of change in the general price level.

CPI

consumer price index. what consumer buy on the daily to meet daily needs. ( measurement of avreaged changes in prices over time)

If inflation is higher than what was expected (fisher effect)

creditors receive a lower real interest rate than they had anticipated. *real interest rate = nominal interest rate - inflation rate If the inflation rate is higher than expected, the real interest rate would be lower than expected.

If inflation is higher than what was expected,

creditors receive a lower real interest rate than they had anticipated. EX: : *real interest rate = nominal interest rate - inflation rate If the inflation rate is higher than expected, the real interest rate would be lower than expected.

If the economy is producing below the natural rate of output in the short-run, wages and input prices will eventually ____ and ____ will increase, returning the economy to long-run equilibrium.

fall / short-run aggregate supply EX: Draw the graph of the aggregate demand, SRAS, and LRAS curve to see the situation. If the economy is producing below the natural level of output, then the SRAS curve has to shift to the right to reach an equilibrium point.

Luquidity

how quickly you can sell and gain money. money is most lquid. old painting (high in vuale). sells easily, gets consumer more money quicker. they buy thing with that money. House, ( Thats an assest, less luquid). need more factors to sell that assest, takes longer to sell with realtor, being on market. not as lquid.

Examples of automatic stabilizers include government expenditures that ____ when national income decreases and help explain why deficits are ____ during recessions.

increase / larger EXPLANATION: Automatic stabilizers are some economic policies that automatically help stabilize an economy. If the national income decreases, thus our consumer spending decreases, the government would increase the government expenditure to stimulate the economy.

Wealth effect.

increase intrinsic value (the real value of money) goes up, and increases consumer spending.

aggregate demand shift left

increased income tax on households increased price level increase on interest rates ( less investments) == decrease in aggergate demand, shifts left.

Which part of real GDP fluctuates most over the course of the business cycle?

investment expenditures

aggregate demand shift right

lower incomes taxes lower price level lower interest rates =(more investments by households)

MPC (multiplier effect of fiscal policy)

marginal propensity to consume 1/ (1-spending. )

Real GDP

measures economic activity and real income.

interest rates (firms pov) ( y-axis is quaintly of money)( x axis is price level)

price level increase, intrest rates increase. price level decrese, intrest rates decrease

calculating Real Interest Rate (fisher effect)

real interest rate = nominal interest rate - inflation rate EXAMPLE: if a loan has a 12 percent interest rate and the inflation rate is 8 percent, then the real return on that loan is 4 percent.

Calculating nominal interest rate (fisher effect)

real interest rate+ expected inflation rate

Assume the MPC is 0.65. Assuming only the multiplier effect matters, an increase in government purchases of $20 billion will shift the aggregate demand curve to the

right by about $57.1 billion The formula to use here is: the government spending / (1-MPC) = 20 / (1-0.65) = $57.1. If the government spending increases, then the aggregate demand curve shifts to the right.

In 2009 President Obama and Congress increased government spending. Some economists thought this increase would have little effect on output. Which of the following would make the effect of an increase in government expenditures on aggregate demand smaller?

the MPC is small and changes in the interest rate have a large effect on investment EX: The MPC would be small in this case because consumers are spending less. And as discussed in lectures, the interest rate would have a great impact on investment for companies, especially when they need to finance or borrow money for projects.

Liquidity refers to

the ease with which an asset is converted to the medium of exchange. EX: The definition of liquidity is: "how easily assets can be converted into cash". (Refer to the handout). Thus, here A is the right option.

Suppose the expected inflation rate increases from 5% to 8%. According to the Fisher effect.

the nominal interest rate increases by 3 percentage points. EX: Fisher effect, it is a one-for-one adjustment of the nominal interest rate to the inflation rate. If the inflation rate increases by 3%, then the nominal interest rate also increases by 3%. The real interest rate is not affected in this case.

Debtor

they have a dept. they take money. they own money

The Fed buys government bonds in open-market operations.

this will increase money supply, shifting money supply curve to the right. equilibrium interest rates will fall. lower interest rates reduces cost of borrowing and returns to savings. encourages households to increase their consumption and investments in new housing. firms also increase investment, building more physical capital. larger quantity of goods and services demanded. so, aggregate-demand curve shifts right. gets pushed up by the other factors

an appreciation of the domestic currency.

value of domestic currency (money), goes up.

money supply and demand diagram. ( price level & money value)

value of money goes up, the price level goes down. value of money goes down, the price level goes up.