Macro Final

Components of aggregate demand

Consumption (C) ; Investment (I) ; government spending (G) ; net exports (X-IM) AD=C+I+G+NX=GDP

The multiplier (1/(1MPC) and the multiplier process

Marginal property to consume (MPC) is fraction of each additional (marginal) $ of disposable income spent on consumption ; change of consumption divide by change in disposable income.

M1 and M2

Money supply (M1)- currency held by the public, plus balances in transactions accounts. ; money supply (M2)- M1 plus balances in most savings accounts and money market mutual funds.

Recession

Occurs when real GDP contracts, (ADD MORE INFO)

Income transfers

Payments to individuals for which no current G or S's are exchanged.

Budget deficit

The amount by which annual gov't spending exceeds gov't...

Current yield

The rate of return on a bond; it's the annual interest payment divided by the bonds price.

Consumption function

The slope of MPC; total consumption = autonomous consumption +income dependent consumption; is a mathematical relationship indicating desired consumer spending at various income levels.

Natural rate of unemployment

The sum of structural and frictional unemployment is referred to as this

Deficit spending

The use of borrowed funds to finance gov't expenditure that exceed tax revenues.

Fiscal policy

The use of gov't taxes and spending to alter macro outcomes.

Real and nominal GDP

Total output (realGDP), AD=C+I+G+NX=GDP

Excess reserves and required reserves

Total reserves -required reserves ; required reserves ratio (r) * total deposits

Output

Total value of G and S's produced.

Autonomous (non income determinants of) consumption

Wealth -an individual's wealth affects his willingness and ability to consume. Credit- availability of credit allows people to spend more than their current income. Taxes- taxes are the link b/t total and disposable income.

1. Explain the basic difference between Keynes' understanding of the business cycle and the Classicals'. Explain how/why these differences translate into different policy prescriptions.

1. Keynes and the classical economists argued that the business cycle occurs. They disagreed on wether they're an appropriate target for government intervention. Keynes believed that government intervention through fiscal and monetary policy are important in keeping the economy running smoothly. On the other hand, Classical economists believe that the markets should be left alone with no human intervention. Keynes argued that without government intervention the markets would collapse. Whereas the Classical economists viewed the markets as self sustaining and that markets could be self sustaining.

Money multiplier (1/r)

1/required reserve ratio (r); the # of deposit (loan) $ that the banking system can create from $1 of excess reserves.

Macro failures

2 failures: 1. Undesirability- the equilibrium price level may not satisfy our macroeconomic goals. 2. Instability- even if the designated macro equilibrium is optimal, it may not last long.

The Fed has three different tools it can use to carry out its monetary policy goals. What are these policy goals? What are these tools? Explain how each tool works.

2. The 3 tools: Open market operations Discount rate Reserve requirements Open market operations: Buying and selling US Government bonds and securities with intent of altering their price. The portfolio decision is the choice of how (where) to hold idle funds: cash or bonds. An attempt to get people to sit on cash or buy bonds. The bond market is the most liquid market in the world. Discount Rate: a rate of interest charged to the bank from the Fed. Discount rate of interest is not a market determined rate. Required Reserves: All banks hold some of the funds that they aquire as deposits in an account at the Fed. What are the constraints on the Fed's monetary policy? 1. Relationship between short term and long term interest rates. 2. Fed needs willing borrowers and lenders. 3. Liquidity trap: is a situation, described in Keynesian economics, in which injections of cash into the private banking system by a central bank fail to decrease interest rates and hence make monetary policy ineffective. which is why it is not effective.

. With reference to the multiplier process and recessions, explain why/how Keynes' theoretical approach to the business cycle constituted a direct attack on the Classicals' theory of a self-equilibrating macro economy.

3. The way Keynes multiplier process is a direct attack on the classical theory is because at first he talks about how businesses will begin to stop investing which will cause an inventory buildup in different factories. This will cause businesses to lower prices and stop producing bulk of their product. This will in turn cause business to cut employment and lower wages which will then decrease disposable income which will cause a decrease in consumer spending. Then this will repeat itself around the country and cause a recession. Something that started off little but then put the whole economy into recession, the snowball effect.

Explain the importance of expectations for Keynes' approach to the macro economy. More specifically how does Keynes link expectations to his understanding of the business cycle's origins?

4. In Keynes eyes business expectations are very important because they are very volatile, they lead to quick and significant changes in investment spending. This is what causes an unstable investment schedule. He argued that investment would fall in response to declining sales regardless of declining interest rates.

What is meant by the short-run inflation-unemployment trade-off in the context of fiscal and monetary policy?

5. Short run inflation and unemployment trade off means that as unemployment decreases the inflation output will increase. However, if the inflation output decreases than the unemployment rate will increase.

In the context of fiscal policy, why it is important to distinguish between direct government purchases/expenditures and income transfers (or tax cuts)?

6. It is important to distinguish between government expenditures and income transfers because income transfers are payments to individuals for which no current goods or services are exchanged. Government purchases are a part of aggregate demand and income transfers are not.

Explain why a given amount of government expenditure (G) will yield more fiscal stimulus than an equivalent amount of tax cuts.

7. It follows that in order for a tax cut to yield the same cumulative (stimulus) effect as a direct government expenditure it must be larger ; ; A tax cut may also be an effective mechanism for increasing investment spending. Tax cuts have been used numerous times to stimulate the economy. ; 7. MPC.. The government will start projects such as roads and schools. They will sign contracts are those contracts will go to employees and then they spend it and so on. When the government cuts taxes and gives that money back there is potential for some people to save that money. When they save that money they don't spend it and that defeats the purpose of the tax cut.

. In the context of the circular flow diagram, explain the key leakages and injections and who in the macro economy is primarily responsible for each.

8. The key leakages come from consumer savings (households), business savings, taxes and imports. The key injections come from business investment, government spending, and exports.

What is the federal open market committee (FOMC) and what does it do?

A 12 member group comprised of the 12 district reserve bank presidents.; overseers the daily activity of the fed and meets approximately every 5-6 weeks to review monetary policy and outcomes.

Consumption function

A mathametical relationship b/t indicating ... Consumer spending at various income levels; total consumption= autonomous consumption +income -dependence consumption

Business cycle

Alternating periods of economic growth and contraction. ; theories try to explain, policies try to control the business cycle.

Inflationary GDP gap

Amount by which equilibrium GDP excepts full employment GDP; leads to demand pull inflation.

Recessionary GDP gap

Amount by which equilibrium GDP falls short of full employment GDP; gap represents ... Productive capacity.

Open market operations

Are federal reserve purchases and sales of U.S. Gov't bonds with the intent of altering their prices (and yields) for the purpose of altering the bank systems reserves.

Determinants of investment

Expectations- play critical role in business' investment decisions. ;Interest rates-businesses typically borrow $ to invest in new plants or equipment. Technology and innovation- new technology changes the demand for investment goods.

In the context of fiscal or monetary policy l, what is the importance of time legs?

If monetary policy works to lower interest rates, but investment doesn't respond relatively quickly, monetary policy's effect on AD will be slow to materialize.

Inelastic investment demand

Investment doesn't respond to interest rate (AD MORE)

Circular flow

Involves the question of whether desired injections will offset desired leakages of full employment.

Leakages and injections

Is income not spending directly on domestic output, but is spent is diverted from circular flow; an addition of spending to the circular flow of income.

Macro equilibrium

Is the combination of price level and real output that is compatible with both aggregate demand and aggregate supply, i.e. Buyers' and sellers' intentions.

Reserve ratio

Is the ratio of the systems reserves to its total deposits ; bank reserves/ total deposits

Aggregate demand (AD)

Is the total quantity of output (real GDP) demanded at alternative price levels in a given time period, ceteris paribus.

Aggregate supply (AS)

Is the total quantity of output (real GDP) demanded at alternative price levels in a given time period, ceteris paribus.

Macro stability condition (I=S)

Leakages-consumer saving, business saving, taxes, imports = Injections-,investment, government spending, exports

Marginal propensity to consume (MPC)

MPC is a fraction of each additional (marginal) $ of disposable income spent on consumption.

Marginal propensity to save (MPS)

MPS=1-MPC ; the fraction of each additional (marginal) $ of disposable income not spent on consumption MPS =change in saving / change in disposable income.