Macroeconomics Exam 2

What are the key principles that define economics?

1.People face trade-offs 2.The cost of something is what you give up to get it 3.Rational people think at the margin 4.People respond to incentives 5.Trade can make everyone better off 6.Markets are usually a good way to organize economic activity 7.Governments can sometimes improve market outcomes 8.A country's standard of living depends on its ability to produce goods and services 9.Prices rise when the government prints too much money 10.Society faces a short-run tradeoff between Inflation and unemployment. Allocate resources for scarcity

What is necessary for growth to accrue?

Achieving long-run growth requires an economy to acquire new resources or to find better ways to use the resources it has to generate goods and services people desire either domestically or abroad through trade. Factors of production (land, labor, capital, ideas) Output = A × f(L, K, H, N) Investment in human capital, technology

Why the slope of aggregate demand curve is negative?

At a lower price level, consumers are likely to have higher disposable income and therefore spend more. (Note this assumes that wages are constant and not falling with prices) If there is a lower price level in the UK, UK goods will become relatively more competitive, leading to higher exports. Exports is a component of AD so AD will be higher. At a lower price level, interest rates usually fall, and this causes higher aggregate demand

What are the determinants of the long run aggregate supply?

Attempts to improve technology such as automation and digitalization are clear examples of an increase in productive capacity. But so is the enhancement of labor quality.

How do average and marginal propensity to consume relates to average and marginal propensity to save?

Average propensities to consume and save represent the proportion of income that is consumed or saved.

How could technology help?

Entrepreneurial ability and ideas, or technology (A) describe the ability to take resources and use them in creative ways to produce goods and services. For example, technology improves the productivity of all factors, and therefore is considered a highly valuable input in production. In other words, land, labor, and physical capital are not useful unless the idea of how to turn these resources into goods and services people want exists. Makes everything more productive

Why government is less keen to increase taxes but more inclined to barrow to pay for spending?

Even in good economic times, tax hikes are politically dangerous, and so are major cuts to government spending programs and transfer programs. The result is that fiscal policy is financed by deficits. Deficits persist in our system of government. public choice theory- The economic analysis of public and political decision making, looking at issues such as voting, the impact of election incentives on politicians, the influence of special interest groups, and rent-seeking behaviors.

How important is the stability of financial system?

Financial stability describes the condition where the financial intermediation process functions smoothly and there is confidence in the operation of key financial institutions and markets within the economy.

How does fiscal policy impact aggregate demand? Aggregate supply? Is the a difference between them?

Fiscal policies that influence aggregate supply are different from policies that influence aggregate demand, as they do not always require tradeoffs between price levels and output. That is the good news. The bad news is that supply-side fiscal policies require more time to work than do demand-side fiscal policies. The focus of fiscal policy and aggregate supply is on long-run economic growth.

What role government plays?

Government policies make work more attractive. Government programs that raise the literacy rate, such as universal public education, also raise the rate of economic growth. By investing heavily in capital goods, the government promotes a higher level of labor productivity in the country. The government also encourages private investment in physical capital through tax incentives and other subsidies to firms willing to invest in capital projects. Enforcements of contracts, Protection of property rights, Stable financial systems, Competitive markets and free trade, Economic freedom.

Is economic growth important? How do we measure economic growth?

Growth is usually measured by the annual percentage change in real GDP, reflecting an improvement in the standard of living. It can lower poverty rates and increase life expectancy real GDP- The total value of final goods and services produced in a country in a year measured using prices in a base year. real GDP per capita- Real GDP divided by population. Provides a rough estimate of a country's standard of living. not everyone is better off from economic growth output has to go up while price stays the same

Can multiplier work in both directions?

If spending increases raise equilibrium income by the increase times the multiplier, a spending decrease will reduce income in corresponding fashion. In our simple economy, for instance, a $100 decline in investment or consumer spending will reduce income by $400.

Was Keynesian assessment about the depression correct?

Keynes had it right: Unless something happened to increase investment or exports (not likely given that the rest of the world was suffering economically as well), the economy would remain mired in the Great Depression (point b). He suggested that government spending was needed. Ten years later (1943), the United States was in the middle of World War II, and aggregate expenditures swelled as government spending rose by a factor of 10. The Great Depression was history.

How do you achieve the equilibrium in a simple aggregate expenditure model?

Keynesian macroeconomic equilibrium The state of an economy at which all injections equal all withdrawals. There are no pressures pushing the economy to a higher or lower level of output

What is compounding growth imply?

Money earns interest Interest earns interest A small change in interest rate can have a large impact over a period of time.

Why the spending multiplier concept is important in macroeconomic?

Multiplier Spending changes alter equilibrium income by the spending change times the multiplier. One person's spending becomes another's income, and that second person spends some (the MPC), which becomes income for another person, and so on, until income has changed by 1/(1 − MPC) = 1/MPS. The multiplier operates in both directions.

What is a short run macroeconomic equilibrium?

Occurs at the intersection of the short-run aggregate supply and aggregate demand curves. At this output level, there are no net pressures for the economy to expand or contract.

How do measure per capita income?

Per capita income, also known as income per person, is the mean income of the people in an economic unit such as a country or city. It is calculated by taking a measure of all sources of income in the aggregate (such as GDP or Gross national income) and dividing it by the total population. For developed county, per capita income is higher

What are the factors influencing the standard of living?

Productivity and investment

What are the implications of short versus long run growth?

Short-run growth occurs when an economy makes use of existing but underutilized resources. For example, abandoned shopping centers or malls could easily be reopened with new stores. Idle construction equipment and unemployed workers could quickly be put into use on a new project. Common when countries are recovering from an economic downturn. Long-run growth occurs when an economy finds new resources or improved ways to use existing resources. In other words, the capacity to produce goods and services increases, leading to long-run growth. For example, suppose natural gas deposits that are estimated to be abundant in the United States are explored, leading to an expansion in production of natural gas-powered vehicles (NGVs).

What are the factors influencing consumption and how important its value is in the aggregate expenditure?

Spending by individuals and households on both durable goods (e.g., autos, appliances, and electronic equipment) and nondurable goods (e.g., food, clothing, and entertainment).

What does the 45-degree line depict?

The 45° line inserted in the figure represents all points where consumption is equal to disposable income (Yd). If an economy spends its entire annual income, saving nothing, the 45° line would represent consumption. Consequently, annual saving (S) is equal to the vertical difference between the 45° reference line and annual consumption (S = Yd − C).

What are the assumptions behind the Laffer curve?

The Laffer curve shows the relationship between average tax rates and total tax revenues. As the tax rate rises from 0%, tax revenues increase. At point c, tax revenues are maximized. If tax rates continue to rise, tax revenues will decrease because higher tax rates discourage people from working and firms from producing. A government collects the same tax revenues at points a or b. The tax rates that correspond to points b and c are often debated by economists. A curve that shows a hypothetical relationship between income tax rates and tax revenues. As tax rates rise from zero, revenues rise, reach a maximum, then decline until revenues reach zero again at a 100% tax rate.

How does export or import impact the aggregate expenditure and level of equilibrium in the economy?

The impact of the foreign sector in the aggregate expenditures model is through net exports: exports minus imports (X − M). Exports are injections of spending into the domestic economy, and imports are withdrawals. Thus, if we import more and all other spending remains the same, equilibrium income will fall. This is one reason why many economists focus on the trade deficit or net exports (X − M) figures each month.

Should be worried about rising public debt?

The public debt is not out of control, at least based on the economy's ability to pay the interest costs. However, rising interest rates will raise the burden of this debt. Even so, at its current size, the public debt is manageable as long as it does not experience another spike in the near term.

Why market force could not overcome the impact of great depression?

This drop in investment reduced spending, and therefore income and consumption, resulting in a deep depression. The increase in aggregate demand necessary to restore the economy back to 1929 levels was huge, and it was no wonder that a 6% increase in government spending had virtually no impact on the Depression. It wasn't until spending ramped up for World War II that the country moved beyond the Depression.

Is there a difference between financial and physical investment?

a physical investment consists in buying a machine tool, a loom, a truck, or a plant, etc., to put it to work a financial investment consists in buying a piece of paper promising some future payments.

What is the paradox of thrift?

paradox of thrift- When investment is positively related to income and households intend to save more, they reduce consumption. Consequently, income and output decrease, reducing investment such that savings actually end up decreasing.

How do we calculate the aggregate expenditure?

Aggregate expenditures Consist of consumer spending, business investment spending, government spending, and net foreign spending (exports minus imports): GDP = C + I + G + (X − M).

What are the determinants of short run aggregate supply?

Changes in input prices, productivity, taxes, regulation, the market power of firms, or business and inflationary expectations.

What are the determinants of aggregate demand?

Consumer spending Investment Government spending and net exports

Is there any downside to economic or population growth?

Food shortage Property Shortage Aging dependency However, population growth means more labor

What is contractionary fiscal policy?

Policies that decrease aggregate demand to contract output in an economy. These include reducing government spending, reducing transfer payments, and/or raising taxes.

Rule of 70

Provides an estimate of the number of years for a value to double, and is calculated as 70 divided by the annual growth rate.

What is demand-pull inflation? How would you address it?

Results when aggregate demand expands so much that equilibrium output exceeds full employment output and the price level rises.

Why the slope of short run aggregate supply is positive?

The short-run aggregate supply curve is positively sloped because many input costs are slow to change (sticky) in the short run.

What are transfer payments and how do they impact the economy?

Transfer payments are money payments paid directly to individuals. These include payments for such items as Social Security, unemployment compensation, and welfare. In large measure, they represent our social safety net. We will ignore them as part of the discretionary fiscal policy, because most are paid as a matter of law

How does tax impact the aggregate expenditure?

When taxes are increased, money is withdrawn from the economy's spending stream. When taxes are reduced, money is injected into the economy's spending stream because consumers and businesses have more to spend. Thus, taxes form a wedge between income and that part of income that can be spent, or disposable income.

Do you think balance budget amendment is a workable solution?

annually balanced budget- Expenditures and taxes would have to be equal each year. cyclically balanced budget- Balancing the budget over the course of the business cycle by restricting spending or raising taxes when the economy is booming and using these surpluses to offset the deficits that occur during recessions.

What are the automatic stabilizers? How do they impact the economy?

automatic stabilizers- Tax revenues and transfer payments automatically expand or contract in ways that reduce the intensity of business fluctuations without any overt action by Congress or other policymakers.

What does average and marginal propensity to consume are measured?

average propensity to consume The percentage of income that is consumed (C ÷ Y). marginal propensity to consume The change in consumption associated with a given change in income (ΔC ÷ ΔY).

What does average and marginal propensity to save are measured?

average propensity to save The percentage of income that is saved (S ÷ Y). marginal propensity to save The change in saving associated with a given change in income (ΔS ÷ ΔY). What do we do with every extra dollar earnes

What is cost-push inflation? How would you address it?

cost-push inflation Results when a supply shock hits the economy, reducing short-run aggregate supply, and thus reducing output and increasing the price level.

What is discretionary fiscal policy?

discretionary fiscal policy- Policies that involve adjusting government spending and tax policies with the express short-run goal of moving the economy toward full employment, expanding economic growth, or controlling inflation.

What is discretionary and mandatory spending?

discretionary spending- The part of the budget that works its way through the appropriations process of Congress each year and includes national defense, transportation, science, environment, and income security. mandatory spending- Spending authorized by permanent laws that does not go through the same appropriations process as discretionary spending. Mandatory spending includes Social Security, Medicare, and interest on the national debt.

What are the time lags? How can it be measured?

information lag- The time policymakers must wait for economic data to be collected, processed, and reported. Most macroeconomic data are not available until at least one quarter (three months) after the fact. recognition lag- The time it takes for policymakers to confirm that the economy is in a recession or a recovery. Short-term variations in key economic indicators are typical and sometimes represent nothing more than randomness in the data. decision lag- The time it takes Congress and the administration to decide on a policy once a problem is recognized. implementation lag- The time required to turn fiscal policy into law and eventually have an impact on the economy.

How important is the level of investment in the economy?

investment Spending by businesses that adds to the productive capacity of the economy. Investment depends on factors such as its rate of return, the level of technology, and business expectations about the economy.

Why the long run aggregate supply curve is vertical? What does it measure?

long-run aggregate supply (LRAS) curve- The long-run aggregate supply curve is vertical at full employment because the economy has reached its capacity to produce. In general terms, the vertical LRAS curve represents the full employment capacity of the economy and depends on the amount of resources available for production and the available technology.

What is multiplier? How do you calculate its value?

multiplier Spending changes alter equilibrium income by the spending change times the multiplier. One person's spending becomes another's income, and that second person spends some (the MPC), which becomes income for another person, and so on, until income has changed by 1/(1 − MPC) = 1/MPS. The multiplier operates in both directions.

What is the difference between national debt and deficit?

national debt- The total debt issued by the U.S. Treasury, which represents the total accumulation of past deficits less surpluses. A portion of this debt is held by other government agencies, and the rest is held by the public. It is also referred to as the gross federal debt.

What are the inflationary or recessionary gaps? How do we measure the gap?

recessionary gap- The increase in aggregate spending needed (when expanded by the multiplier) to bring a depressed economy back to full employment. inflationary gap- The spending reduction necessary (when expanded by the multiplier) to bring an overheated economy back to full employment.