Economic analysis and policy revieiom

What is a firm (micro 1)

A company which produces and sells goods or services for the purpose of making a profit.

Arc elasticity is the ratio of two areas (micro 5)

A decrease in revenue due to a decrease in the quantity purchased (Q0-Q1) x p0+p1/2. Divided by: An increase in revenue due to an increase in the amount paid for each unit purchased under the new price (p0-p1) x Q0+Q1/2.

Domestic of domestic currency (macro 22)

A decrease in the exchange rate.

Financial assets (macro 6)

A financial asset is a piece of paper entitling the owner to a stream of payments over a specified period.

Commercial banks (macro 6)

A financial intermediary, co-ordinating activities between savers and borrowers. They borrow money from the money to lend.

What effects the slope of the LM curve (macro 21)

A flat LL curve, demand for money is very responsive to r. Desired cash holdings are sensitive to interest changes. Income changes lead to relatively small interest rate changes. This implies a relatively flat LM schedule. Minimal crowding out of private spending.

What does a flat ii curve suggest (macro 25)

A flat ii curve suggest a relaxed policy towards inflation targeting. This will result in a steeper AD curve.

The balance of payments (macro 22)

A record of all transactions between the residents of one country and the rest of the world. It is the sum of current, capital and financial accounts.

Austerity (macro 5)

A reduction in G-NT. Our analysis suggests that a recession is the wrong time for austerity. Austerity measures will worsen decreases in output.

When the economy is operating below full employment what does the paradox of thrift state that? (Macro 4)

A reduction in desired savings will increase spending and increase equilibrium output

What is a risk averse person (micro 10)

A risk averse person dislikes risk. This person will never take a fair gamble (gambles for which the expected change in wealth is equal to 0).

What is a risk loving person (micro 10)

A risk loving person sees risk as a good. This person takes gambles even when the odds are unfavourable. A risk loving person has increasing marginal utility over income (convex utility). (see diagram). In this case EU(175,25;0.5)>E(100). This person will accept a gamble for which EV=38 which is the case when p=0.09. This implies that EU(175,25;0.9)=E(100). This risk seeking individual is willing to accept very unfavourable odds.

What will an increase in income (Y0<Y1) lead to in the ISLM (macro 7)

A shift right in the money demand curve. As households income increases, they need more real cash holdings for increased comsumption. Holding the supply of money fixed, an increase in Y must lead to an increase in interest rates.

What does a steep ii curve suggest (macro 25)

A steep ii curve suggests an aggressive policy towards inflation targeting. This will result in a flatter AD curve.

Marginal and average product of labour (micro 2)

'Productivity of labour' almost always refers to the average product of labour. 𝑑𝑄(𝐾 ,𝐿) 𝑄(𝐾 ,𝐿) 00 𝑀𝑃𝐿= 𝑑𝐿 , 𝐴𝑃𝐿= 𝐿 When MPL>APL then APL is increasing. When MPL<APL then APL is decreasing. When MPL=APL then APL is at its maximum value.

How do income taxes create another labour market distortion (macro 29)

(See diagram)

Industry labour market (micro 9)

(see diagram). An industry with dangerous or unpleasant working conditions will find it difficult to attract workers. This is represented by an inelastic labour supply curve. The equilibrium wage will reflect a premium for the difficulty involved in recruiting workers. An industry with pleasant working conditions, or requiring very little skill will find it easy to attract labour. This is represented by an elastic labour supply curve.

Does immigration hurt domestic workers micro 9)

(see diagram). Equilibrium is initially at w0. Immigration increases the supply of labour. This drives down the market wage as the new immigrants compete for jobs with domestic workers. How large is this negative wage effect.

Is minimum wage bad for the labour market (micro 9)

(see diagram). Equilibrium is initially at w0. Say that win is the government imposed minimum wage. Our labour market model shows that there will be winners and losers from this policy. The Ld workers who are employed benefit from a higher wage. Ls-Ld workers are unable to find employment at the minimum wage.

The labour supply curve (micro 9)

(see diagram). The intersection on the vertical axis will reflect the reservation wage, wr. There will also be a wage, w', after which labour supply begins to decrease. The labour supply curve is backwards bending.

Benefits of fixed regime (macro 22)

1. A fixed exchange rate regime provides stability. 2. This is attractive to foreign and domestic investors. 3. Can be used to avoid inflation (i.e gives the central bank a money supply target).

Costs of a fixed regime (macro 22)

1. Central bank must keep a large stock of foreign reserve at all times. 2. If capital is perfectly mobility in and out of country, loose control of interest rate.

What determines the cost of production output q (micro 3)

1. The price of the capital that was used in production. 2. The price of the labour that was used in production. 3. The production technology (i.e. productivity of inputs). In the short run, capital inputs are fixed. Therefore, the cost of capital makes up the fixed cost of production. In the long run all inputs, and therefore all costs can be varied.

Why do we hold money (macro 7)

1. Transaction. 2. Precautionary. 3. Asset.

short run equilibrium (4 macro)

Actual outlut is equal to AD

The cost of holding money (macro 7)

All wealth held in money rather than bonds forgoes the interest that bonds earn. The cost of holding money when the interest on bonds is greater. Money demand is decreasing with interest rates (coterie paribus).

Appreciation of domestic currency (macro 22)

An increase in the exchange rate.

What would an exogenous increase in the supply of real balances have on the LM schedule (macro 8)

An increase in the money supply shift's the LM curve to the right.

Expected value and expected utility numerical example (micro 10)

An individual has W=£100, and is offered a lottery in which the good state G=150, the bad state B=50, and p=0.5. Then the expected value of this lottery is: EV=0.5x150+0.5x50=100. The expected utility of the lottery is: EU(150,50;0.5)=0.5xU(150)+0.5xU(50)

Shifting the LM (macro 8)

Changes in the money supply (L) for a given income level will shift the LM curve.

Aggregate unemployment (macro 28)

Closey related to the aggregate supply curve, we want to distinguish between long run and short run unemployment. The equilibrium or 'natural' rate of unemployment is observed when the economy is at its potential output.

Equities (macro 6)

Company shares, entitling the owner to receive corporate dividends. Low liquidity.

Market structure and cost structure (micro 7)

Competitive markets. Each firm hits minimum efficient scale at a relatively low quantity. Many firms are needed to meet the total market demand. Natural monopoly. These are markets in which it only makes sense for one firm to supply. This arises from the cost structure. Large fixed cost involved in entering the market. Oligopoly. Somewhere in the middle. Firms have a fairly large minimum efficient scale. Not quite large enough to provide entire market.

Perfect competition market structure (micro 4)

Firms are price takers. Firms are free yo enter. Firms produce an identical product. Firms all have perfect information about the market. Short run equilibrium P*=MC. Firm's may make short run (supernormal) profits or losses.

Reasons to question the assumption that wages adjust instantly (macro 27)

Firms are reluctant to let go of/hire employees if a demand shock is temporary. Hiring new employees is costly. Firing may involve redundancy/severance payments to employees. Employees find it costly to leave their employer, even for higher wages elsewhere. Work contracts require the ability of firms to adjust employee hours and wages when market conditions change. These contracts are periodically renegotiated. Contractual wage growth is negoaiated according to expected inflation. In the short-run, output is only affected by inflation when, actual inflation + expected / or = expected inflation. Actual inflation>expected inflation=output prices grow faster than wages. Firms increase output=positive output gap. Actual inflation<expected inflation=putput prices grow slower than wages. Firms decrease output=negative output gap. In the long run wages adjust to new inflation expectations and output returns to the potential output.

Where does supply come from (macro 25)

Firms making production decisions. Individuals supplying labour. Resources and production technologies available in the economy.

With perfect capital mobility, fixed exchange rate regime (macro 23)

Fiscal policy can be used to influence domestic output. Monetary policy cannot be used as a policy instrument, it cannot control both e and r.

Demand side policy in the classic model (macro 26)

Fiscal policy fully crowds out private spending. It has no effect on the level of output, only on the composition. Fiscal policy is not an effective tool for stimulating the economy. Monetary policy can be used to change the inflation outcome but not eh outcome for either the level or composition of output. Policy recommendation: Use monetary policy to hold inflation steady. Use fiscal policy as sparingly as possible.

With perfect capital mobility, floating exchange rate regime (macro 23)

Fiscal policy is ineffective for influencing domestic output. Monetary policy can be used to influence domestic output.

Production in the long run (micro 4)

For a given level of output, the firm will choose the combination of inputs that minimise the cost of production. Consider if labour costs £1 per unit and capital costs £3 per unit. The total cost of inputs, C, will be given by: £1xL+£3xK=C. We can draw, in (L,K) space, the relationship between labour and capital at a constant cost.

Production in the long run graphically. The long run total cost function.(micro 4)

For any given q, we can always find the minimum cost combination of capital and labour. The tangent points between isocost and isoquant for each q give the optimal input mix. For every q there is a unique C. Therefore, we have a functional relationship between q and the minimum cost of production. This is the long run total cost function.

Exchange rate (macro 22)

Foreign currency/£. This is the number of units of foreign currency needed to purchase one pound.

What are gains from trade (micro 2)

Gains from trade refer to the net benefits (incremental production in this case) to all economic agents from entering in voluntary trade with each other.

Monetary control (ISLM) (Macro 7)

Given the money demand schedule, LL, the central bank can either, set the interest rate and let the money supply adjust or set the money supply and let the interest rate adjust. It cannot set both the money supply and the interest rate independently. The Bank of England prefers to work by setting interest rates.

Supply curve (micro 3)

Graphical representation of the supply schedule in price and quantity space. The supply curve depicts s ceteris paribus relationship: the change in quantity supplied when price changes holding everything else constant.

Write the monetary base as (macro 6)

H=C+R = cpD+cbD.

What is a company (micro 1)

Have a legal existence distinct from the owners. Can raise money through the buying and selling of shares. Owners of shares have limited liability in the company, they are not responsible to repay creditors beyond the value of company.

Inflation targeting (macro 25)

ISLM assumes that the central bank sets money supply to target a desired interest rate in the economy. In the past this is roughly how central banks operated. Today, most central banks target inflation.

The relationship between average costs and marginal costs (micro 3)

If MC>AC then AC is increasing. If MC<AC then AC is decreasing. If MC=AC then AC is minimum.

How does supply change with changes in the general price level (macro 25)

If a firm that experiences doubling in the cost of production and a doubling in the price of its goods will not change production. Workers that experience a doubling of wages and a doubling of all prices will not change labour supply. We assume that agents in our model do not suffer from money illusion. If they did, this would create arbitrage opportunities. Without money illusion, the real supply of goods and services is unaffected by nominal changes in the price level. This is consistent with the classical dichotomy.

Knowing how expenditure responds to a price change in important (micro 5)

If a good is taxed will it increase government revenues? Is taxing cigarettes an effective way to decrease smoking? Can a monopolist firm profitably increase price? In addition, we want a metric that will allow us to make meaningful comparisons across different markets. Looking at the change in expenditure (or price and quantity) directly will not allow provide this.

What shifts the marginal revenue curve (micro 1)

If demand shifts up, consumers are willing to pay more at each q, then MR will also shift up. The firm's profit maximising q and p, will increase. The price of raw materials used in the production process increases. The cost of each unit of production will therefore increase. Notice, changes in the fixed cost will not effect the marginal cost. Therefore, fixed cost has no impact on the choice of q. Unless fixed costs are so large that profits are negative.

Why does unemployment stay high after a recession (macro 29)

Insider-outsider theory: A recession leads to a temporary shift in labour demand. Newly redundant workers are now 'outsiders'. When the recession ends 'insiders' use their influence to increase wages rathe than hirer workers.

Dynamics of a temporary supply shock (macro 27)

Increasing the number of short term work visas. Shift in short run supply, but not long run supply. SAS shifts right, inflation falls below target at the current level of output (B) which has fallen from A. Excess demand at lower prices drives up prices. Positive output gap (C). Eventually short run supply shifts back to its original position (A). Temporary supply shocks does not lead to permanent changes in output or inflation.

What is a risk natural person (micro 10)

Indifferent and takes all gambles which are fair. It implies that utility is a straight line; MU is the same at every point. They make decisions base on the expected value of a lottery.

Who are the winners and losers from inflation (macro 25)

Inflation benefits borrowers but it hurts lenders. The problem is, leaning contracts are often written in nominal terms. When inflation becomes unpredictable, lenders become cautious about lending. This will increase interest rates (real and nominal) which decreases borrowing.

What is a key objective of monetary authority now (macro 26)

Inflation targeting. This ensures that inflation is predictable. This predictability of inflation is important. Borrowers and lenders to can account for inflation in repayment schemes. Contracts for future purchase of goods and services can account for inflation.

The UK's balance of payments (macro 22)

Net exporter in services. Not importer in goods.

What does a flat IS schedule mean (macro 21)

Output is very responsive to changes in interest rates. Monetary policy is very effective. Small interest rate changes lead to big output responses. Large changes in interest rates needed to change output.

The Keynesian view of aggregate supply (macro 27)

Perfectly elastic aggregate supply. Aggregate supply fully responds to demand shocks. Why don't factor prices adjust when demand changes.

The classical view of aggregate supply (macro 27)

Perfectly inelastic supply at long run potential output. Prices fully adjust following aggregate demand shocks. Demand shocks only influence inflation. The classical model is logically satisfying compared to the Keynesian mode, but cannot explain 'output gaps'. These are when the economy goes through relatively long deviations from potential output.

What is policy mix (macro 21)

Policy makers way wish to coordinate monetary and fiscal policy. In times of fiscal austerity, coordination with monetary policy may be useful. Demand management can be used to stabilise output at a desired level. The UK policy over the last decade has been 'tight' fiscal with 'easy' monetary.

What is a production function (micro 2)

Knife production: Capital and labour are inputs, also called factors of production. Knives are the output in this production process. We use a production function to summarise the technology available to the firm in the combination of inputs to produce units of output. Q=f(K,L). The production function reflects only technically efficient ways to combine inputs to produce outputs (on the firm's PPF)

What is the demand equation for real money balances (macro 7)

LL= a+bY-Y(r-rd). These symbols are not correct so look at macro 7. Where a >0, b>0, and Y>0 are parameters and rd is the interest that is paid on bank deposits (possibly 0) again check symbols.

What are the factors of production (micro 1)

Land, capital, labour enterprise.

Why do some industries have monopoly provision (micro 7)

Legal monopoly. Anticompetitive behaviour. Natural monopoly.

Why not always use monetary policy to stimulate the economy (macro 21)

Limits to how low the interest rate can go.

Bank reserves (macro 6)

Money that a bank has available to meet possible withdrawals from depositors.

Representative money

Money that represents. a claim on commodity

Numerical example of a monopolies long run output decision (micro 6)

Monopolist faces demand Q=50-0.5P and has costs TC=100+4Q. Rewrite the demand function as: P=100-2q. pi=(100-2Q)Q-(100+4Q). dpi/dQ=100-4Q-4=0 ---> Q=24, P=52. pi= (100-2Q)q-(100+4Q)=(100-48)24-(100+96)=1052. (see diagram) This can be plotted out. The monopolist profit is given by the shaded are pi=1052.

Entry deterrence and anticompetitive behaviour (micro 8)

Monopolist firms have a big incentive to deter competition. Not only do they have to split profits with potential entrants, but completion erodes total profits. Barriers to market entry can be innocent or strategic. This can be done through strategic entry deterrence. We can use game theory to think about the ability of a monopolist firm to keep out potential entrants. 1. Entrant enters, incumbent fights. 2. Entrant enters, incumbent accepts. 3. Entrant stays out.

NT (macro 5)

NT. an either take the form of a lump sum tax or proportional tax.

What happens when there is a decrease in foreign interest rates (fixed exchange) (macro 24)

The BP curve is horizontal at the point where domestic and foreign interest rates are equal. rf decreases, holding e and Yf constant. Domestic currency starts to appreciate (currency demand increase in foreign exchange). Central bank responds by increasing the funds in foreign exchange market. Domestic interest rate falls to foreign interest rate. Investment and household spending increases in response to the lower interest. Output increases.

The BP curve (fixed exchange)

The BP curve is horizontal at the point where domestic and foreign interest rates are equal. rf decreases, holding e and Yf constant. Domestic currency starts to appreciate (currency demand increases foreign exchange). Domestic goods are becoming expensive relative to foreign goods. Net exports fall. Money demand decreases, until domestic and foreign interest rates are equal. Output falls overall.

The international value of the domestic currency (macro 22)

The British pound currency trades for 1.20 Euros (EUR).

Cobb-Douglas production technology

The Cobb Douglas production technology is easy to think about returns to scale with: q(K,L)= 𝐾𝛼𝐿𝛽. If I double all factors of production, by how much will output change? 𝑞 2𝐾,2𝐿 = 2𝐾 𝛼 2𝐿 𝛽 ⇒𝑞 2𝐾,2𝐿 =2𝛼+𝛽𝐾𝛼𝐿𝛽 ⇒𝑞 2𝐾,2𝐿 =2𝛼+𝛽𝑞 𝐾,𝐿 If 𝛼 + 𝛽 > 1 then increasing returns, If 𝛼 + 𝛽 = 1 then constant returns,If 𝛼 + 𝛽 < 1 then decreasing returns

The domestic price of foreign exchange (macro 22)

The Euro current trades for 0.83 British pounds. This is the domestic price of foreign exchange, or the cost in pounds of one Euro.

What happens to the CA when the exchange rate increases (macro 23)

The current account decreases.

What happens to the CA when foreign income increases (macro 23)

The current account increases.

What happens to the CA when domestic income increases (macro 23)

The current account will decrease.

The demand for money (macro 7)

The demand for money refers to the demand for real money balances. We only care about the precasting power of money, not the normal value.

What does the LL curve depicts (macro 7)

The desired holdings of real money balances at each interest rate. LL is a function of income (output). Changes in output shift LL at every rate of interest.

What is the capital account (macro 22)

The difference between the value of domestic assets purchased by foreign investors and the value of foreign assets purchased by domestic investors. The capital account depends positively on the difference between the domestic interest rate and the foreign interest rate.

General equilibrium (macro 27)

The economy is in a short run equilibrium at the output-inflation combination (Y, pi), such that SAS=AD. The economy is in a long run equilibrium output-inflation combination (Y, pi), such that SAS=AD and Y=Y*. If the economy is in a long-run equilibrium then it is also in a short run equilibrium.

Budget constraint (micro 9)

The slope of the budget constraint reflects the opportunity cost of leisure: w units of consumption. As with other goods, the individual optimally chooses leisure time where MRS=w.

Liquidity (macro 6)

The speed at which an asset can be turned into money.

national debt

The stock of outstanding government debt.

Positive economics (micro 1)

The study of the way things a

Normative economics (micro 1)

The study of the way things should be. Based on subjective beliefs.

Pooling of non independent risks (micro 10)

The subprime housing market is a good example of a failure to properly pool risk.

What is the balance of payments the sum of (macro 22)

The sum of the current, capital and financial accounts. BP= CA+kA. If CA>0 then the country is in a current account surplus, income from foreign spending exceeds spending on foreign goods. If CA<0 then the country is in a current account deficit, income from foreign spending is less than spending on foreign goods. In every period the balance of payments must sum to 0.

What happens when the goods market is in equilibrium, but the money market is not (macro 21)

The supply of real balances exceeds the demand for real balances. Households and firms use their excess funds to purchase bonds, which drives down the interest rate. The new, lower, interest rate stimulates investment by firms, which increase AD and output.

What happens in the money market if interest rates fall (macro 21)

There is a movement down the LL curve. Households/firms sell bonds to free up more cash. This drives down the price of bonds (up the interest rate). This will happen until interest is at r*.

What happens in the money market if interest rates rise (macro 21)

There is a movement up the LL curve. Households and firms use their excess cash to purchase bonds. This drives up the price of bonds (down the interest rate). This will happen until the interest rate goes back down and there is a movement down the LL curve.

What are changes in monetary policy reflected by on the ii curve (macro 25)

They are reflected by a shift in the ii curve. They will shift the AD curve.

Automatic stabilisers (macro 5)

They are used to d,a pen the response of the economy to shocks. It is the use of automated taxes and transfers for the purpose of offsetting the economy's response to contraction and expansion. For e ample proportional taxes and unemployment benefits.

What do changes in inflation and interest rates that are defined by the same ii curve (same monetary policy) cause (macro 25)

They result in movements along the AD curve.

What does the central bank do if they wish to increase the exchange rate (macro 22)

They shift the supply curve left.

What does the central bank do if they wish to decrease the exchange rate (macro 22)

They shift the supply of curve right.

If the monetary authority fixes the exchange rate, what happens if demand decreases (macro 22)

To keep the pound from depreciating, the Bank uses US$ in its foreign reserves to purchase domestic currency and tale it out of the market.

How does insurance work (micro 10)

Pooling independent risks reduced overall risk exposure. This is how insurance works. A health insurance company reduces its overall exposure to risk by insuring across lots of independent individuals. My probability of needing expensive surgery tomorrow is independent of your probability of needing expensive surgery tomorrow. The more people who are insured, the lower the risk to the insurer. The insurance company takes an insurance premium from the users in exchange for reducing risk exposure.

Diminishing marginal returns to labour (micro 2)

Production function: Q(K0,L)=K0,L^0.5 Q(10,L)=10L^0.5 Q(20,L)=10L^0.5. (see diagram). Notice, for a larger value of K, the slope of the production function at a fixed value of L increases. Increasing capital increases the marginal product of labour. (see diagram). Marginal production of labour: (dq(k0,L)/dL)=0.5(K0/L^0.5). (dQ(10,L)/dL= 5/L^0.5. (dQ(20,L))/dL= 10/L^0.5.

How should an economy allocate productive resources (micro 2)

Production of a good X should be allocated to agents (people, firms, countries) with the lowest opportunity cost first and the higher opportunity cost last.

Productivity of labour (micro 2)

Productivity of labour is often measured as the average output per unit of labour (usually per worker or per hour). From the perspective of the firm, productivity is important. Higher productivity of labour means each worker paid for produces more output. From the perspective of the economy, productivity is important. a country can only grow richer if workers either work more or become more productive.

Monopolistic competition (micro 7)

Products across firms are imperfect substitutes. Products are heterogenous. Investments are made in product differentiation. Each firm faces a downward sloping demand curve. Firms can set there price to some extent. Limited opportunities for economies of scale. Firms tend to be small.

What is the firm's main objective (micro 1)

Profit maximisation. Profits=total revenue-total cost. The firm's problem is to choose the value of q to maximise profits. Price is the maximum price for which q units of the good can be sold. This comes from the market demand curve for the firm's product.

Average productivity of labour (micro 2)

Q/L

Demand function explained (micro 3)

Q=a-bP Quantity intercept=a Price intercept=a/b Slope=1/b.

How are shifts the curves are easy to represent mathematically (micro 4)

Qd=a-bP The demand schedule. Qs=c+dP The supply schedule. Qs=Qd The market clearing condition. A shift to the right in demand means that the parameter a increases. P*=a-c/b+d Q*=bc+da/b+d. Therefore, P* increases and Q* increases. A shift to the right in supply means that the parameter c goes up. Therefore, P* decreases and Q* increases.

Demand function (micro 3)

Qd=a-bP. More complex: Qd=a-bP+gY+hPs-kPc Y=population income. Ps=price of susbsitlte good. Pc=price of complement good.

Supply function (micro 3)

Qs=c+dP. Quantity intercept=c Price intercept=-c/d Slope=1/4

Quantitive easing (macro 8)

Quantitative easing refers to action taken by the central bank to increase the money supply. It aims to create this 'new' money, we aim to boost spending and investment in the economy.

Policies that may change the natural rate of unemployment (macro 29)

Restricting and reducing the power of unions. Restrictions on income support programmes. Reducing income taxes and taxed on firm profits. Minimum/living wages. Antitrust/competition laws. Worker training programmes and requirements.

Breaking up the different components of the cost function into average costs (micro 3)

SATC=C(q)/q' SAFC=F/q' SAVC=VC(q)/q.

Short run versus long run (macro 2)

Short run: at least one factor of production is fixed. Long run: all factors of production can be varied. We generally assume capital to be fixed and labour to be variable in the short run. MPL=Q(K0,L)-Q(K0,L-1). In discrete units or MPL: dQ/dL in continuous units.

Bills (macro 6)

Short term asset with a known date of repurchase at the known price. High liquidity.

Open economy (macro 22)

Small means that the countries decisions will not effect world prices (world prices are exogenous). An open economy has trade and financial links to other countries (foreign economies) which will impact the domestic economy.

Central banking (macro 7)

Strong central banks operate independent of the government. Politics do not influence monetary policy. Countries with greater independence of the central banking system tend to have lower inflation.

Assumptions of out IS-LM-BP model (macro 24)

Supply is perfectly elastic and responds immediately to changes in demand. Imports and exports are perfectly interchangeable. As a result, prices do not respond to shifts in demand (no inflation in model).

What effect would an exogenous increase in government spending have on the IS schedule (macro 8)

The AD curve shifts up, with no change in the interest rate. For each interest rate, the goods market equilibrium is at a higher output level. The IS curve shifts to the right.

Absolute advantage (micro 2)

Producing more of something with the same inputs.

How does the price level effect aggregate demand (macro 25)

1. Consumption: wealth effect. Simple economy in which the only goods are food and clothing. Individuals have a fixed nominal wealth W. Inflation increases the price of food and clothing by the same amount, but does not effect nominal wealth. Consider a decrease in the general price level from P1 to P2. This implies that nominal wealth now has more purchasing power. The demand for real goods increases. 2. Investment: wealth effect. Individuals distribute a fixed stock of wealth between spending and spending. Both can be thought of as 'normal goods'. When the price level increases, from P1 to P2, the nominal wealth has less purchasing power. Individuals respond by reducing current consumption and savings. 3. Net exports: Exchange rate effect. Foreign demand is increasing when the real value of domestic goods and services decreases: real exchange rate= e x P/Pf. For all of these reasons, the AD curve slopes downward.

The supply of pounds in the foreign exchange market can come from two sources (macro 22)

1. Firms, household and government purchases on foreign goods and services. 2. Central monetary authority for the purpose of influencing the exchange rate. The bank is running down its foreign reserves.

Why do firms experience economies of scale (micro 4)

1. Indivisibilities in the production process (i.e. a large piece of capital needs to be purchased regardless of how much or little use it receives. At least one manager is needed, half a manager cannot be purchased). 2. Specialisation. 3. Network effects in production (learning or teamwork effects). Decreasing returns to scale effect the concentration (and therefore competitiveness) of firms in the market. Industries with a high minimum efficient scale have fewer firms.

The roles of central bank (macro 7)

1. Issue bank notes. 2. Lender of last resort. A banker to the government. It may also be the job of central banks to police the financial system. 5. Monitoring and controlling the money supply, interest rated&inflation.

What are the three things that determine firm behaviour and profits (micro 1)

1. Market demand for the good and firm produces. 2. The firm's cost of production. 3. The competitive environment the firm faces.

The functions of money (Macro 6)

1. Medium of exchange of goods and services 2. Unit of account in which prices are quoted and accounts are kept. 3. Store of value. 4. Standard of deferred payment.

Increasing the quantity sold has two effects on revenue that move in different directions (micro 1)

1. More units sold, which increases revenues. 2. The firm must lower the price, which decreases revenue. The total effect on the firm's revenues depends on which effect dominates.

Which three equations describe an equilibrium (micro 4)

1. Qd=a-bP The demand schedule. 2. Qs=c+dP The supply schedule. 3. Qs=Qd The market clearing condition. These equations can be used to solve for the equilibrium P and Q, (denoted Q*,P*). P*= (a-c)/(b+d). Q*= (bc+da)/(b+d).

Ways the central bank can influence the money supply (macro 7)

1. Reserve requirements. The bank sets the minimum ratio of cash reserves to deposits that commercial banks must meet. This comes from the money multiplier relationships. As the reserve ratio (cb) increases, the money multiplier decreases. 2. Setting the bank rate. This is the interest rate that the bank charges when commercial banks want to borrow. Increasing this rate penalises commercial banks when they need to borrow, encouraging them to hold more excess reserves. 3. Open market operations: buying or selling financial securities in the open market.

What effects the slope of the IS curve (macro 21)

1. Steep AD curve means a high MPC. 2. I and C are very sensitive to changes in r. Small changes in interest rates can lead to big changes in the goods market. This implies a relatively flat IS curve.

Assumptions about firms (micro 1)

1. The firm's objective is to maximise profits. 2. The firm produces a single good. 3. The firm has perfect information about market demand for its product. 4. The firm must sell all units of its product at the same price. 5. For the moment we ignore interactions between firms.

The two components of total costs (micro 1)

1. The fixed cost. 2. The variable cost. TC(q)=F+cxq. Total cost is never decreasing in the amount of a good produced.

What are the three components of the ISLM model (macro 21)

1. The goods market, which determines output. 2. The money market, which determines interest rates. 3. The condition that both markets must be in equilibrium at the same time, which determines the relationship between output and interest rates.

Taylor rule (macro 27)

A Taylor rule describes a more complicated monetary policy. How responsive are nominal interest rates (r) to deviations in inflation versus output. Look at the equations. a and b capture the relative importance of inflation and output in monetary policy. Notice if b=0, then the Taylor rule is just the inflation targeting policy that we looked at in the classic model.

What is the ii schedule (macro 25)

A graphical depiction of the central bank's monetary policy. Targeted real interest rate for all levels of inflation. Higher inflation=higher real interest rate (higher nominal interest rate). Bank policy does not directly influence pi. The Bank forecasts pi and then sets r to achieve the desired value of i. A single curve reflects an entire policy. Movements along the curve do not reflect policy changes.

Demand curve e (micro 3)

A graphical representation of the demand schedule in price and quantity space.

Short run cost of capital (micro 3)

A large piece of machinery may be expensive, but also very durable. How do we think about the short run fixed cost of this purchase (r in the previous equation). r could represent the rental/lease paid for capital. r could also represent the opportunity cost of a piece of capital. 1. Forgone rental revenue (from a different firm) 2. Depreciation (purchase price less value at the end of short run period). (see lecture slides for a numerical example). We have written the firm's cost function as C(q)=FC+VC(q). The firm has two inputs, K and L. The cost function is C=rxK0+wxL. The short run production function for a firm tells us the relationship (based on available technologies) between K0,L and q. This information can be transformed into a relationship between the short run cost of production and q. a(K0,L)--->C(q). If we have the production function, we can derive a cost function as above.

What is a market (micro 3)

A market is a means of transferring goods and services from one person (agent) to another. In markets: Exchange is reciprocated (both parties receive and give up something). Exchange is voluntary. There is competition (many sellers and many buyers).

Demand shock adjustment to long run equilibrium (macro 27)

A negative demand shock (not caused by monetary policy). AD falls and firms respond by lowering prices (but not wages) and output (through labour reductions). As time passes, inflation expectations change, firms and workers begin to renegotiate wage contracts. After enough time, all wage contracts are renegotiated in line with new lower inflation expectations. Short run: Output falls (and employment) and then gradually increases, prices and wages gradually fell. Long run: no change to output, lower prices and wages.

What is a supply shock (macro 26)

A supply shock is anything that unexpectedly shifts the supply curve from its current potential level.

Perpetuities (macro 6)

A type of bond which is never repurchased by the issuer. Interest payments made forever. Medium liquidity.

Fixed exchange regime (macro 22)

Actions are taken by the central bank to fix exchange rates at a pre-determined level.

What does arc elasticity provide us with (lecture 5)

An estimate of elasticity around discrete points. As these points get closer together, the estimate becomes more precise.

Exchange rate regimes (macro 22)

An exchange rate regime refers to the government's policy with respect to how exchange rates are determined.

Isoquant (micro 4)

An isoquant provides a graphical depiction of the relationship between inputs for a given output level. Changing the output level shifts the isoquant. Different technologies will have different shaped isoquants.

Fiat money (macro 6)

Any currency without intrinsic value.

Shifting the IS (macro 8)

Anything that shits the AD curve for a given interest rate will shift the IS curve. Changes in G. Exogenous changes in C or I that are not due to changes in r.

Demand-defficient unemployment (macro 29)

Arises from a fall in aggregate demand (jobs become unavailable). Only corrects when AD returns to its long run level.

The law of demand (micro 3)

As the price of a good increases, ceteris paribus, the quantity demanded decreases.

The cost function (micro 3)

Assume capital to be fixed and labour to be variable in the short run. STC=SFC+SVC or C(q)=F+VC(q). (see diagram). Marginal costs reflect the incremental difference one more unit of production makes to costs. SMC=C(q)-C(q-1). Or SMC=dc(q)/dq. if C(q) is a continuous function.

Profit maximisation for a price taking firm numerical example (micro 4)

Assume that C(q)= F+2q+0.5q^2. Solve for the profit maximising q. pi(q)=Pxq-(F+2q+0.5q^2). Taking the derivate and setting equal to 0 we get (dpi(q))/dq= P-2-q=0 = q=P-2.

Equilibrium (micro 4)

Assumptions about the market: 1. Large number of sellers and a large number of buyers in the market. Everyone in the market is a price taker. No one buyer/seller can influence the equilibrium price. 2. All goods in the market are identical (e.g. no variation in quality) 3. Buyers and sellers have perfect information about all available options. This is a competitive market.

If the monetary authority fixes the exchange rate, what happens if demand increases (macro 22)

At e1, the demand for pounds is greater than the supply. There is pressure on the pound to appreciate. The Bank must print pounds and trade them for dollars, shifting the SS curve. The e1 x (Q2-Q1) units of American currency are added to the Bank's foreign exchange reserve.

When does LMC cross LAC (micro 4)

At the minimum value of LAC.

Expected utility (micro 10)

Attitudes toward risk depend on the shape of the utility function. Diminishing marginal utility implies that individuals are risk averse.

How can the Bank of England influence interest rates (macro 7)

By purchasing or selling large amounts of government bonds, bank buys bonds, must offer a higher price to entice bond holders to sell. This puts downward pressure on interest rates. Banks ell bonds, must offer a lower price to entice cash holders to buy. This puts upward pressure on interest rates.

Bundles (micro 2)

Bundles of food and clothing can be changed, for example, by moving the fixed number of workers between the fields and also the factory.

The difference between movements along and shifts in the demand curve (micro 3)

Changes in price=movement, as they change quantity demanded. Changes in anything else=shift.

Difference between movements along and shifts in the supply curve (micro 3)

Changes in price=movement. Changes in anything else=shift.

Arc/midpoint elasticity calculation (micro 5)

Calculating arc elasticity: Arc elasticity of demand, for a price quantity change (Q0,P0) to (Q1,P1) is: PEDarc= Q1-Q0/(Q1+Q0)/2/P1-P0/(P1+P0)/2. We calculate elasticity using the Arc (a.k.a midpoint) method when we have two discrete price/quantity coordinates. With discrete changes, calculate percentage relative to the midpoint (called the arc elasticity). When the price of a good changes from £6 to £4, the quantity demand changes from 20 units to 40 units. Calculate the elasticity. %Change in Qd= 40-20/(40+20)/2= 0.67. %Change in P= 4-6/(4+6)/2= -0.4. PEDarc= %change in Q/ % change in P= -(0.67/0.4)= -1.67.

What effect with a debt financed increase in G, coordinated with an increase in the money supply (macro 21)

Can use government spending to stimulate the economy without the crowding-out.

Currency depreciation (macro 23)

Change in exchange impacts the demand for domestic goods and services. When domestic currency depreciates, e decreases, domestic goods become relatively inexpensive. When domestic currency appreciates, e increases, domestic goods become relatively expensive. All else equal: when the domestic currency depreciates the IS curve shifts right.

Movement along the ISLM curves (macro 8)

Changes in Y or r are reflected by a movement along the IS and LM curves. They are endogenous variables.

Fiscal policy in ISLM

Consider a debt financed increase in government spending. It would shift the AD curve up, the IS curve shifts right, from Y*0 to Y1. At Y1, the goods market is in equilibrium, but the money market is not. The increase in Y has increase the demand for real balances. This leads to a movement along the IS curve as interest rates increase (to r*1). Higher interest leads lead to reductions in I and reductions in C, partially offsetting the initial increase in Y. The new equilibrium is at Y*2, r*1. Some private spending (C and I) has been crowded out by the increase in interest rates (movement from Y1 to Y*2).

Short run unemployment and inflation (macro 28)

Consider a demand shock (not caused by monetary policy). (See diagrams). This suggests a negative short run relationship between inflation and unemployment.

Elasticity along the demand curve (micro 5)

Consider a price change of change in P units. The PED will depend on where along the demand curve this change happens. At relatively large values of Q, the increase in the denominator is greater than the decrease in the numerator. -1<PED<0. At relatively small values of Q, the increase in the denominator is less than the decrease in the numerator. PED<-1. On any linear demand curve: Every point has a different elasticity. There are as many elastic as inelastic points.

Cartel (micro 8)

Consider a two firm cartel. Each firm produces q, earning profits equal to area A. (see diagram). If one firm increases production to q'. Profits decrease due to a price decrease (area B). Profits increase due to the quantity increase (area C). The other firm's profits decrease by area B. Market profits decrease. MC=AC. Even though both firms are better of colluding, this is an inherently unstable agreement. Both firms can increase their individual profits by deviating from the agreement. Therefore, both firms have an incentive to deviate.

Monopoly comparative statics: cost increase (micro 6)

Consider an exogenous increase in production costs. Both MC and AC shift up. Quantity decreases and price increases. The monopolist sets price and quantity at a more elastic portion of the demand curve. Profit decrease.

Monopoly comparative statistics: cost increase (micro 6)

Consider an exogenous increase in production costs. Both MC and AC shift up. Quantity decreases and price increases. The monopolist sets price and quantity at a more elastic portion of the demand curve. Profits decrease. Consider an exogenous decrease in demand. Both MR and demand curve shift left. Quantity and price both fall. Profits fall.

Policy analysis with the IS-LM-BP model: Fiscal policy with fixed exchange rates (macro 23)

Consider an increase in government spending. The domestic economy moves up the LM curve to point B. At B, r>rf. Demand for domestic currency leads to currency appreciation (e increases). To stop the appreciation, the Bank increases the supply of domestic currency. The LM shifts outwards to new equilibrium at C. Fiscal policy is effective in increasing output.

Extensive margin labour supply (micro 9)

Consider an individual with preferences that result in an indifference curve that is steep relative to the budget line. (see diagram). That is MRS(L=24,C=M).=>W. Now it goes up MRS(L=24,C=M)<w. So the individual will choose L<24 and enter the labour force. The smallest wage wr, for which MRS(L=24, C=M)=wr is called the reservation wage. If w> or equal to wr then work. If w<wr then do not work.

Social cost of monopoly, monopoly versus perfect competition (micro 7)

Consider an industry where all firms have a flat long run marginal cost curve (see diagram). The monopolist chooses Pm and Qm. Monopolist profits are area A. Consumer surplus is area A+B. The perfectly competitive equilibrium is Pc and Qc. Firm profits are 0. Consumer surplus is the shaded area (see diagram). The difference in total social surplus between the monopolist and perfectly competitive industry is given by area C. Area C reflects the dead weight loss or social cost, of monopoly provision.

Demand shock with inflation targeting (macro 27)

Consider the effect of a demand shock that is not caused by a change to monetary policy. The bank can use monetary policy to stabilise the economy at a target inflation rate at potential output. As long as the bank can respond quickly to demand shocks, monetary policy is an effective tool for stabilisation.

Labour supply (micro 9)

Consumption and leisure are constrained by income and time. Let: H=number of hours individual allocates to work. w=the hourly wage that work pays. The consumers time constraint can be written as: 24=L+H the consumer's consumption constraint is: C=wxH. Using the time constraint to substitute for H: C=wx(24-L)=24w-wL.

Classical unemployment (macro 29)

Created when the wage is deliberately maintained above its equilibrium level. Minimum wage.

Calculating arc elasticity numerical example (micro 5)

Demand for a good: Qd=60-8P. Calculate the elasticity for an observed price change from P0=0.5 to P1=0.75. Find the corresponding change in quantity and the midpoint: Q0:56. Q1:54. Q1+Q0/2=55. P1+P0/2=0.625. Calc

Modern view on unemployment (macro 29)

Stresses the differences between voluntary and involuntary unemployment.

The linear demand/linear cost case (micro 1)

Demand is given by: P=a-BQ. Cost function: C(q)=F+cq. 𝑞∗ = 𝐴 − 𝑐 /2𝑏 𝐶(𝑞) 𝑃∗ = 𝐴 + 𝑐/2 TR*: A^2-c^2/4b C*=F+(Ac-c^2)/2b. pi*=((A-c)^2/4b)-F

Discretionary fiscal policy (macro 5)

Decisions that are made, on a case by case basis, to change spending and tax rates to stabilise aggregate demand.

Exogenous supply shift (micro 4)

Decrease in supply. We move from an initial equilibrium at A to a new equilibrium at C. There is a supply shortage at the price P1. We move from an initial equilibrium at A to a new equilibrium at C.

What legally do two things need to be established to determine if a firm qualifies as a monopolist (micro 6)

Define the relevant market. Show that the firm has the ability to substantially influence pricing in that market.

What does the concave shape to a PPF suggest (micro 2)

Diminishing marginal returns to production. We derived this as a result of differences (or heterogeneity) in productive skills across the individual's in the economy. Rather than skills this could represent limitations of the production technology. A production functions for which each additional unit of input results in a smaller increment in total output than did the previous unit.

When are gains from trade possible (micro 2)

Diversity (or heterogeneity) in the population is necessary. Differences in tastes (preferences) for goods in question. Differences in skills or production technology. Differences in opportunity cost.

Policy analysis with the IS-LM-BP model: monetary policy (fixed regime) (macro 23)

Does not work. In a fixed exchange rate regime the money supply is endogenously determined by the economy. The policy maker gives up control of the money supply in exchange for control of the exchange rate.

Variables in the money market (ISLM) (Macro 7)

Endogenous variables in the money market (move along curves): 1. Interest rates, r. Exogenous variables in the money market (shift curves): 1. Income/output, Y 2. Nominal money balances, M. 3. Price level, P.

Policy analysis with the IS-LM-BP model: Fiscal policy (floating exchange regime) (macro 23)

Expansionary fiscal policy. The government increases spending, which shifts the IS curve right. A domestic equilibrium, B, r>rf. This increase in domestic interest rates leads to an appreciation in the domestic currency. Currency appreciation shifts the IS curve left (as net exports fall). The economy shifts back to equilibrium A. Fiscal policy is completely ineffective (crowds out exports).

Policy analysis with the IS-LM-BP model: Monetary policy with floating exchange (macro 23)

Expansionary monetary policy. The money supply increases shifting the LM curve right. At domestic equilibrium B, r<rf. Reduction in the demand for domestic currency (for investment) leads to a devaluation of currency. The currency devaluation means that net exports increase, the IS curve shifts right. This happens until the new equilibrium at C is reached. Monetary policy is effective.

What happens to expected utility if the gamble is riskier (micro 10)

Expected utility for the riskier gamble is lower.

Foreign trade (Macro 5)

Exports (X) and imports (Z).

Aggregate labour supply (micro 9)

Extensive. The willingness of individuals to participate in the labour force will vary: Different preferences. Different non labour income. As the market wage increases more individuals participate. Intensive. Individuals may increase or decrease their work hours following a wage increase. Empirical analysis suggests that in aggregate, wage increases lead to greater hours worked=substitution effect>income effect. Upwards sloping aggregate labour supply curve.

Interests rates reflect the opportunity cost of what (macro 7)

Holding cash balances,

What happens when there is a decrease in the supply of money (ISLM) (macro 7)

Holding everything else equal, a decrease in the supply of money will lead to a higher interest rate on bonds. Open market operations: central bank reduces the money supply by selling bonds on the open market. To entice buyers they offer a lower price, a higher rate of interest. This increases the opportunity cost of holding cash and household purchase bonds. The bank taxes money used to purchase bonds out of circulation.

What happens to the demand for money as incomes increase (macro 7)

Households need more cash for consumption transactions. Holding all else constant, the demand for real balances increases.

How does changing the real economy affect interest rates (lecture 8)

Households: 1. Higher income increases the demand for real money balances (to meet increase consumption demand). 2. This shifts the LL curve right (in r, L space) and increases the equilibrium interest rate.

How does changing interest rates (and therefore the money supply) affect the real economy?

Households: 1. Lower interest rates imply higher prices of bonds. Households feel wealthier, consumption increases. 2. Lower interest rates imply lower cost of borrowing, increases spending on consumer durables, consumption increases. Investment by firms: 1. Lower interest rates imply lower cost of borrowing, increasing investment by firms.

Equation of exchange (macro 25)

How often does money change hands over a given time period MV=PY. V is the speed at which the stock of money passes around the economy. If people hold money for less time, money passes more quickly. less money is needed relative to nominal income. PY is nominal GDP.

General formula for the real rate of interest (macro 26(

I=principle. r=nominal interest rate. pi=inflation rate. I=real interest rate. The real interest rate is. I=I(1+r)(1-pi)-I/I

Formula for the real rate of interest (macro 25)

I=principle. r=nominal interest rate. pi=inflation rate. I=real interest rate. The real interest rate is: I=I(1+r)(1-pi)-1/I= (1+r)(1-pi)-1=r-pi-rpi, we ignore the last bit, rpi as it is generally very small. i=r-pi.

Why not an inflation rate of 0 (macro 25)

I=r-pi. With a 0% target the bank runs the risk of negative inflation (deflation) To decrease the real interest rate the bank will need to set negative nominal interest rates. Monetary policy looses its effectiveness. Better to have a bit of inflation.

Unemployment across geographic space (macro 29)

If labour is perfectly mobile across geographic space, we should expect to see equalisation of unemployment rates across geographic space.

Fiscal policy in the classic model (inflation targeting) (macro 26)

If the central bank is targeting inflation, then it will changes its policy rule as a result of the government's fiscal policy. 1. For every [I set a higher real interest rate. 2. Desired investment household spending decreases in response to the higher interest rates. 3. This leads to a leftward shift in the AD curve. 4. There is a downward pressure on prices, which increases household spending and net exports. 5. In response to the deflation, the Bank lowers real interest rates, increasing investment spending. 6. Overall, the government spending still fully crowds out private spending, but there is now no inflation.

Fiscal policy in the classic model (no inflation targeting) (macro 26)

If the government increases spending, AD shifts right. Now AD>AS, therefore the general price level starts to increase. The increase in the general price level means households reduce their spending (negative wealth effect), net exports decreases. The central bank increases real interest rates. At the new equilibrium, the general price level has increases and government spending has led to full crowding out of private spending (No change in Y).

Point elasticity (micro 5)

If we have the formula for the demand curve, we can measure the exact elasticity for a specific point. PED= (dQd/dP) x (P/Qd). The first bracket is the derivative of demand with respect to price. Point elasticity reflects elasticity for marginal changes. For a linear demand function dQd/dP is the slope parameter. Therefore if the demand curve is QD=50-2p dQd/dP=-2.

Milton Friedman's aggregate supply model (macro 25)

In 1968 a radically different model of supply was proposed by Milton Friedman. The supply curve is vertical at its potential level of output (the 'natural' level). The classical model of money supply assumes that economy is always operating at potential output. Potential output is treated as given, it is the long run equilibrium output. The equilibrium inflation level is pi0. At this level: Goods market equilibrium, AS=AD. The money market is in equilibrium. The labour market is in equilibrium: No workers wish to change their labour supply at the prevailing wage. No firm wishes to change its production level at the prevailing wage. At pi1 which has gone down, AS<AD. This puts upward pressure on prices and wages (pi increases), which decreases the demand for output. At pi2 which has gone up, AS>AD, this puts downward pressure on prices and wages as firms compete to sell excess inventories and shed labour. The fall in the price level increases the demand for output.

The story of Venezuela (macro 24)

In 2014, the world demand for Venezuela's oil falls quickly and sharply. A large decrease in net exports. A depreciation of the bolivares in foreign exchange markets. Imported goods and services become relatively expensive. The oil industry is largely nationalised to fund significant social programmes: G=NX!. Oil revenues made up the bulk of government spending. G is funded by printing money. Further depreciation on the bolivaries. Imported goods and services become even more expensive (local prices are increasing). Why does the IS curve not shift back up (net exports increase). Net exports are the problem. What happens next is not captured by out current model. The domestic economy was unable to simply 'take over' production of imported goods and services. Domestic price levels began to rise very rapidly. In respond to this Venezuelans started to get rid of their bolivares. This led to a further decrease in domestic interest rates, further depreciation of the bolivares and greater increase in prices. Hyperinflation. Increasing the minimum wage did little to address the affordability of goods and services. Likely added to inflation problems.

Distinction between short run and long run in a perfectly competitive market (micro 4)

In the short run the number of firms is fixed. In the long run the number of firms is allowed to vary. Firms make decisions based on long run costs. Entry and exit takes place until the market price is just equal to the long run average costs of production for the last firm to supply.

Oligopoly (micro 7)

In an oligopoly industry there are only a few large firms which directly compete with one another. there is collusion and this is strategic.

Why our model does not fit with the story of Venezuela (macro 24)

In our model: Domestic investment will respond to the decrease in interest rates leading to an increase in output. Domestic production will respond to higher prices for imports by increase domestic output. The domestic economy will have lower interest rates and increased output. But this did not happen. Our model is missing a crucial feature: domestic production does not instantaneously respond to changes in demand.

What is missing in our ISLM model (macro 24)

In the ISLM model we assumed that prices and wages are fixed. This implicitly assumes that the economy is never at full capacity. There are always unemployed workers who wish to work at the current wage. There is always unused machinery and resources that are available at the current prices. To relaxed this assumption we need aggregate supply.

Monopolistic competition long run equilibrium (micro 7)

In the long run equilibrium firms are not producing at minimal average cost (unlike with perfect competition). Firms produce where MC<AC. Expending production would reduce costs, but the increase in revenue would be too low. There is some monopoly power as P>MC (unlike perfect competition). Firms are maximising profits, but just break even as P=AC.

The firms long run output decision (micro 4)

In the long run the firm must be covering all of its costs to stay in business. As before, the firm will choose a production level, q*, where MR(q*)=LMC(q*). The firm will only stay in business if it will make non negative profits: P(q*)xq*-LTC(q*)> or equal to 0. Which implies that P(q*)> or equal to (LTC(q*))/q*. P(q*)> or equal to LAC(q*) the firm must be covering its long run average cost of production. q* is chosen such that MR(q*)=LMC(q*). The market price at this quantity is given by P(q*), the profit maximising firms makes positive profits. Now consider what happens with a different demand, LAC(q*)>P(q*). So the profit maximising firm will shut down.

Total, marginal and average costs

In the long run, there is no fixed cost involved (i.e. shutting down is always an option).

Real versus nominal interest rate (macro 25)

In the model of the economy so far we have not explicitly made a distinction between the real and nominal rate of interest. We want to be clear here: r=nominal interest rate. pi=inflation rate. I= real interest rate. I=r-pi. This is known as the Fisher equation. Note that it actually reflects an approximation of the real interest rate.

Aggregate labour market's ability to clear depends on the time frame (macro 27)

In the short run (months): Fluctuations in labour supply come largely from hours (as opposed to employment). employees can be asked to work more or fewer hours. Wages are unlikely to change. In the medium run (6 months to 2 years): Firms begin to adjust their permanent work force. Employment contracts come up for renegotiation. This puts pressure on wages. In the long run (>2 years): All contracts are renegotiated. Wages fully adjust to new labour demand.

Monopolistic competition diagram explained (micro 7)

In the short run a firm may enter a new industry and make positive profits. over time, other firms notice the profits and enter the industry. This shifts the incumbent firm's market demand left. Other firms continue to enter until the incumbent's demand is just tangent to average cost.

Will technology take our jobs shown on the Phillips curve (macro 30)

In the short run output increases, but not all the way to its new potential. Large increases in unemployment. In the long run output increases, all the way to its new potential level. This is because previously unemployed workers are rehired. Inflation decreases.

Exogenous demand shift (micro 4)

Increase in demand. There is a shortage in supply at price P1. (see diagram). Buyers express a higher willingness to pay, sellers start to raise their prices. We move along the curves D2 and S1 to the new equilibrium. We move from an initial equilibrium at A to a new equilibrium at B.

What is the money market equilibrium (macro 8)

Is defined by interest rate r*, such that money demand is equal to money supply.

What is the goods market equilibrium (macro 8)

Is defined by output level Y*, such that aggregate demand and actual income (output) are equal.

What does the classical theory assume in the quantity theory of money (macro 25)

It assumes that prices/wages adjust to hold Y=Y* (neutrality of money). V is constant. This implies that any changes to M must be met with a proportional change in P. MV=PY. Increases in the money supply always lead to inflation. Note that the quantity theory is a classical theory. Increasing the money supply to stimulate GDP will only lead to more inflation. If V is not constant, it becomes difficult to infer any relationship between money and inflation.

The UK productivity puzzle (micro 2)

It can be broken into two parts: 1. For decades UK productivity has been low relative to other rich countries. 2. The UK has experienced almost no productivity growth since 2008.

What is the 45 degree line (macro 21)

It corresponds to the circular flow diagram, all hypothetical points for which output and demand are equal.

What does the current account depend on (macro 23)

It depends on domestic income, foreign income and the exchange rate.

What does the capital account depend on (macro 23)

It depends on the difference between the domestic interest rate and the foreign interest rate. r-rf>0= capital flows into domestic economy, KA increases. r-rf<0= capital flows out of domestic economy, KA decreases.

The Phillips curve (macro 28)

It describes the negative short run relationship between inflation and unemployment. Police makers face a trade of between inflation and unemployment. Pi=pie+b(U-U*)= U-U*= 1/b(pi-pie). U* is the long run, natural rate of unemployment. The vertical line at U* suggests the natural one,ployment rate is not related to inflation. (see diagram). PC shows the short run Phillips curve. This is the short run employment rate holding inflation expectations fixed. This curve is the employment counterpart to the short run aggregate supply curve.

The natural rate of unemployment (macro 29)

It entirely reflects voluntary unemployment. The natural rate of unemployment= N1-N*/N1.

What does a shift in either ISLM schedule mean

It implies that the equilibrium relationship between Y and r has changed in the respective market.

The labour force (macro 29)

It is comprised of all the people who are employed to are actively looking for work at the current wage rate. It does not include people who are out of the labour force.

What is an equilibrium in the goods and money market for the open economy determined by (macro 23)

It is determined by the intersection of the IS/LM/BP curves.

Using a balanced budget multiplier as a fiscal tool (macro 4)

It is not politically feasible. It involves raising taxes for greater expenditures. It involves replacing some private spending with public spending. Once we include interest rates in the model, we will also see that government spending crowds out capital investment from firms.

What is perfect capital mobility reflected by on the BP curve (macro 23)

It is reflected by a horizontal BP curve.

What is perfectly immobile capital reflected by on the BP curve and how does the economy respond to a demand shock (macro 23)

It is reflected by a vertical BP curve. The BP curve is horizontal at the point where domestic and foreign interest rates are equal. The way in which the economy will respond to a demand shock depends on the exchange rate regime. Fixed exchange rate: exchange rates are exogenous, money supply is endogenous. Floating exchange rate: exchange rates are endogenous, money supply is exogenous.

Will technology take our jobs (macro 30)

It makes a large number of workers become obsolete. We show this as a shift left in the labour demand curve. At each wage, fewer workers are demanded. Because wages are sticky, in the short run there is a large increase in unemployment to N1-N2. In the long run. Wages are lower. Fewer people are in the labour force. Unemployment stays the same.

Decreasing the unemployment benefits affect on the unemployment rate (macro 29)

It may effect the unemployment rate. Decreasing benefits changes the opportunity cost of remaining employed.

Perfect capital mobility

It means that there are no impediments to funds flowing from one currency to another. If returns (interest rates) in one country increase (with no change in risk), investors have an incentive to move funds (capital) to that economy. When capital mobility is high investors become more responsive to changes in relative returns between countries. With perfect capital mobility, funds will always flow to the economy with the highest rate of return.

What is the current account (macro 22)

It measures the real value of trade balances (Exports-imports). This was previously denoted by NX=X-Z= CA. The current account is increasing in foreign income, decreasing in domestic income and increasing with the exchange rate. The current account will also include items not in the net exports, such as foreign aid.

What is capital mobility (macro 22)

It refers to how easily an investor can move funds (financial capital) in and out of a country. It refers to capital mobility depends on regulation of international financial transactions.

What does the BP curve reflect (macro 23)

It reflects combinations of domestic interest rates and domestic output for which the balance of payments equals zero. BP= CA+ka<0. An increase in domestic income will increase import demand (decrease net exports). Current account deficit. To reestablish equilibrium, interest rates must rise. Foreign investment flows in, increasing the capital account.

What does aggregate supply reflect in the ISLM model (macro 24)

It reflects the interaction of the markets for goods and labour.

What is the IS schedule (macro 8)

It shows combinations of Y and r for which the goods market is in equilibrium.

What is the LM schedule (macro 8)

It shows combinations of Y and r for which the money market is in equilibrium.

What does the AD curve show in the goods market (macro 21)

It shows the aggregate demand for goods and services at each level of output (which is also income).

What does the short run aggregate supply curve show the relationship between (macro 27)

It shows the relationship between the output gap and inflation. pi= pi+𝜃Y-Y*)+p (symbols are not all correct. When output deviates from potential output, we see a movement along the SAS curve. The slope of the SAS curve, 𝜃, reflects how responsive prices/wages are to changes in inflation. When 𝜃 is close to 0, wage stickiness is high. A larger value of 𝜃 suggests that wages are less sticky (closer to the classical model).

Quantity theory of money (macro 24)

It states that the price level is directly proportional to the nominal money supply. A % change in nominal money supply leads to a same % change in the price level. V is the speed at which the stock of money passes around the economy.

What does capital mobility refer to (macro 23)

It will refer to the slope of the BP curve relative to the LM curve.

What effect with changes in G have on the IS schedule (macro 21)

It will shift the IS schedule. G is an exogenous variable in the ISLM model.

What effect will changes in L=M/P have on the LM curve (macro 21)

It will shift the LM curve. L is any exogenous variable in the ISLM model.

Bonds (macro 6)

Longer term assets. Medium liquidity.

Write the money multiplier as (macro 6)

M/H = (cp+1)/(cp+cb).

Real money supply (macro 7)

M/P

Write the money supply as (macro 6)

M=C+D= cpD+D.

A steep LM curve (macro 21)

Money demand is not very responsive to changes in interest rates. Fiscal policy is much less effective. A bond financed increase in government spending shifts the is schedule outwards. Big increase in r, little change in Y. Public spending has crowded out a lot go private spending.

The IS and LM schedules (macro 8)

Mathematically, the IS and LM curves are projections of equilibrium values from each market into the same (Y,r) space. This allows us to see when both markets are in equilibrium.

Balanced budget (macro 4)

Means that the government will set taxes such that government spending is always covered. When the government runs a balanced budget in every period taxation will always be adjusted such that: NT=G and consumption is C=A+c(Y-G). When the government runs a balanced budget, government spending offset by a tax increase will always increase in output.

Examples of near monopoly firms (micro 6)

Microsoft operating system. Google. Railways companies. Public services.

Price floors (micro 4)

Minimum price. Minimum wage. Price floor: prices must not go below the floor.

The real exchange rate (macro 22)

Nominal exchange rates reflect the exchange rate between different currencies, but they do not tell us about the purchasing power of different currencies. If there is inflation in the UK, holding the exchange rate constant, more US dollars will be needed to purchase UK marmite. The real exchange rate reflects the relative price of actual goods and services when measures in different currencies. e= nominal exchange rate (international value of domestic currency). pf= foreign price level. P= domestic price level. Real exchange rate= exp/pf= the relative price of foreign goods.

Will a risk averse person ever take a risky gamble (micro 10)

Notice, U(100) is equal to the expected utility for a gamble with an expected value of £160. (see diagram). This will be the case if p=0.9. eu(175,25;0.9)=U(100). This risk averse person will only take the gamble with very favourable odds.

Policies to influence output (macro 21)

Notice, changes in interest rates and output lead to movements along the IS curve and LM curves (they are endogenous variables).

What happens when there is an increase in foreign interest rates (macro 24)

One way to show 'a reduction in foreign investor appetite for UK assets' is to increase rf, holding e and Yf constant. At the initial interest rate we are in a BP deficit. Capital begins to leave the UK seeking the higher foreign interest rate, r1f. Domestic currency depreciates. Currency depreciation leads to an increase in the demand for domestic goods and services, as well as an increase in the domestic interest rate.

Hysteresis (macro 29)

Our model so far suggest that once the factors that lead to a fall in aggregate demand have been removed unemployment will return back to normal. However, empirically a (short run) fall in aggregate demand can lead to persistent unemployment when the fall in demand has been reversed.

Where does price come on (micro 1)

Price comes from the demand curve. The defamed curve shows the maximum willingnwaa of consumers to pay for different quantities of a good. We write this as P(q)

Price discrimination (micro 7)

Price discrimination is when a firm change charge different prices to different people.

The price taking firm (micro 4)

Recall the firm's problem is to choose q to maximise profits. For the perfectly competitive firm this can be written as: pi(q)=pXQ-C(q). Notice that the firm's choice of q no longer influences P. P is now an exogenous variable for the individual firm. Taking the derivate and setting equal to 0 we get. dpi(q)/dq=P-(Dc(Q))/DQ=0=p=MC(q).

What form do the government bonds tend to take (macro 7)

Receive a flow of annual payments (the coupon) until the repayment date, at which time the government will buy the bond for £100. The yield is calculated as (100+coupon x years - price)/price all x 1/years. Price and yield are inversely related.

Stabilisation policy (macro 4)

Refers to actions taken by the government to move aggregate demand output (close to potential output)

Structural unemployment (macro 29)

Reflects unemployment that arises from workers needing to adjust to a change in the types of jobs available.

The firm's output decision (sunk fixed costs) (micro 3)

Remember, profit maximising output is where MR=MC. If P>SATC at q, then the firm is making a profit. SAVC<P<SATC, then the firm looses money in the short run/ P<SAVC1, then the firm shuts down (produces 0). (see diagram).

Supply shock in the classic model (macro 26)

Say a country experiences a large positive supply shock. As more output is supplied than demanded, the country experiences decrease in the rate of inflation from the target of pi* to pi*0. The central bank uses monetary policy to decrease the real rate of interest (decreasing the ii curve). This is done by increasing the money supply and hence the nominal rate of interest. The decrease in real interest rates shifts the AD curve outwards to AD'. Nominal interest rates are higher and the money supply is higher. Inflation is back at its target level.

Marginal product of labour (micro 8)

Say profits are given by: pi=Pxq(K,L)-wL-rK. Assume K is fixed. Taking the derivative and setting equal to 0 P(dq(K,L))/dL-w=0 or P(dq(K,L)/dL=w. Notice if both P and w increase by the same amount then L will not change.

Economies of scale (micro 4)

Scale refers to the output of a firm when all inputs can be varied. It is a measure of size. Returns to scale refer to the relationship between long run average costs and output. There are three cases of interest: 1. Increasing returns to scale: LAC is decreasing as q increases. 2. Constant returns to scale: LAC does not change as q increases. Decreasing returns to scale: LAC is increasing as q increases.

Why is inflation so bad (macro 25)

Shoe leather costs: The negative effects of inflation can be avoided by holding less money. This means that people will make more frequent trips to the bank to change their savings into cash. Menu costs: It is costly for firms to change their prices. Misallocation costs: If some businesses find it easier to change their prices than others, then inflation distorts the role of prices in reflecting the relative value of different goods and services.

Calculating opportunity cost from a schedule of bundles (micro 2)

Start from a PPF bundle of F units of food and Cf units of clothing, (Cf,F). What is the opportunity cost of moving to a PPF bundle with F' units of food? The opportunity per unit of food is: OCfood= CF-CF'/F1-f. This is calculated to the left for movements of F'-F=1. For example, when F=4, F'=5, then Cf=5.6, Cf'=5. Therefore: OCfood= 5.6-5/5-4=0.6. This reflects the average number of clothing units that must be sacrificed per new unit of food produced. We can also calculate OC for clothing. Opportunity cost depends on where we start on the PPF.

Monopoly case study (micro 6)

Steel industry in Egypt.

Supply side economics (macro 29)

Supply side economics requires the use of microeconomic incentives to alter: The level of full employment. The level of potential output. The natural rate of unemployment. In the ling run, the performance of the economy can only be changed by affecting the level of full employment and the corresponding level of potential output. Modern economics does not view the natural rate of unemployment as fixed. It can be altered by structural change including: Labour force mobility. Income support programmes. Market competition. It may also be altered by Changes in the age distribution. Cultural factors.

The firm's objective, numeric example using a linear demand and quadratic cost:

TC(q)=10+2q+0.1q^2. P(q)=20-0.5q. TR(q)=(20-0.5q)q=20q-0.5q^2. We could just find MC and MR and solve: MC(q)=2+0.2q MR(q)=20-q. Setting MC=MR: 20-q=2+0.2q= q=15. Alternatively, we could solve by maximising profits. Profits can be written as. Pi(q)=20q-0.5q^2-(10+2q+0.1q^2). Simplifying a bit, pi(q)=18q-0.6q^2-10. 𝜕𝜋(𝑞) = 18 − 1.2𝑞 = 0 𝜕𝑞 Therefore 𝑞 = 15.

A permanent supply shock (macro 27)

Technology increases leading to higher productivity. Both AS and SAS curves shift right. Inflation and output move to short run equilibrium B. In the short run there is a negative output gap. Firms and workers adjust their inflation expectations downwards, shifting the SAS curve right. Inflation and output move to C.

Price elasticity of demand (micro 5)

The % change in the quantity demanded of a good given a 1% change in the good's price. PED=% change in Qd/%change in P. PED is always negative. This is because the demand curve is downward sloping. One demand curve is more elastic than another if the elasticity is a larger magnitude. For example, -1.5 is more elastic than -1.

Elasticity of supply (micro 5)

The % change in the quantity supplied of a good given a 1% change in the good's price. PED= %change in Qs/ % change in P.

Aggregate supply in the ISLM model (macro 25)

The ISLM model that we studied up until this lecture implicitly assumed that supply is perfectly elastic. At low levels of output, below potential output: capital is under-utilised at current rents, labour is unfertilised at current wages, firms and workers are always willing to provide more output with no effect on inflation. The model that is shown represents the Keynesian model of supply prior to 1960. There is a logical inconsistency with this model of the economy. Why do firms not offer their under-utilised capital at lower rents? Why workers, who would like to work at the prevailing wage, offer their labour at a lower wage? In competitive markets this should lead to a decrease in the general price level. Under-utilised factors of production should always put downward pressure on prices.

Gains from trade (micro 2)

The PPF illustrates the production trade offs an economy faces. Heterogeneity is necessary for gains from trade to exist. Either: People differ in their tastes. People differ in the production capabilities. If people differ in production capabilities, the economy's PPF will exhibit diminishing marginal returns to production. An economy maximises its production capabilities by allocating production to the producers with the lower opportunity cost. This parallels the problem of gains from international trade. Gains from trade can be realised if production takes production takes place in countries with comparative advantage.

PPF bundles (micro 2)

The PPF tells us the bundles of production that are possible. It, by itself, does not tell us which bundle of production is best.

Commodity money (macro 6)

The actual use of valued commodity as a form of money.

A price for good X in terms of resource Y (micro 3)

The amount of Y that must be exchanged for a unit of X.

Perfectly inelastic demand (micro 5)

The change in QD=0. The change in price equals the entire shift in supply. PED= (The change in Qd/The change in price) x (P/Qd)=0. Change in expenditure is entirely due to the increase in price.

Perfectly elastic demand (micro 5)

The change in Qd equals the entire shift in supply. The change in price is equal to 0. PED= (The change in Qd/The change in P) x (P/Qd)=-infinity. Change in expenditure is entirely due to a decrease in quantity.

Sticky wages (macro 27)

The classical model assumes that inflation reflects a uniform change across all prices and wages in the economy. No relative price changes. It must be that all prices are changing by the same amount at the same time. In the short run, this assumption is a little strong.

Production possibility frontier (micro 2)

The concept of opportunity cost for an economy can be depicted by the production possibility frontier. It depicts all possible combinations of food and clothing when resources and production technology are fully utilised.

Budget deficit (macro 4)

The excess of government spending over government receipts (taxes) in a year.

Floating exchange regime (macro 22)

The exchange rate is determined by the market for foreign exchange equilibrium. It allows the exchange rate to adjust to its equilibrium value.

The multiplier (4 macro)

The feedback that happens between output and income when we see a change in aggregate demand.

The firm's objective example (micro 1)

The firm faces the following linear (inverse) demand curve: P=20-0.2q. A cost function given by: C=5+q. Profit maximising at Q*: maxpi(q)=(20-0.2q)q-(5+q). q*=47.5

Price takers short run supply curve (micro 4)

The firm takes the P as given. It is profitable to produce up until the marginal cost of production is just equal to P. If the market price is less than the firm's SAVC (as at P1), then the firm's optimal production is 0. The firm's short run supply is: 0 if P<P1 q auch that SMC(q)= P if P> or equal to P1. In the short run, firms may Mae supernormal profits. Consider if the price is at P. (see diagram). The supernormal profits made by the firm are reflected by the blue rectangle. Free entry into the market means that supernormal profits cannot be sustainable in the long run. Similarly, losses cannot be sustainable in the long run. The market price P is influenced by the total supply in the market.

Total costs (micro 1)

The firm's cosys=full economic costs. This reflects both the accounting cosy and the opportunity cost of an action. We must weigh the benefit of increased revenue from greater carrying capacity against the opportunity cost of the money+congestion cost if we want to purchase more cars.

The relationship between production technology and costs (micro 3)

The functional form of the cost function will be determined by the functional form of the production function. A unit of capital costs rental r and unit of labour costs wage w. Consider the short run prediction function: q(K0,L)=K0xL^0.5. We can rearrange the production function to reflect the amount of labour needed for a chosen amount of input: L=(q/K0)^2. Replace L in the function C= r x K0+wxL: C=rK0+w(q/K0)^2. Notice that q is the only variable (in the short run, r, K0 and w are all fixed). Given that K0 is fixed, we can write this firm's production function in the form: 𝐶 𝑞 = 𝐹 𝐶 + 𝑤ෝ 𝑞 2 Where FC=rK0 and w= w/K0^2. (The symbols are incorrect) The +wq^2 is the VC(q)

Monopolies firms long run output decision (micro 6)

The fundamental difference between a monopolist market and a perfectly competitive market is the monopolist firm's decision will influence the market price pi(Q)=P(Q)xQ-TC(Q). The monopolist is a price setter. The monopolist will consider the market demand when choosing the quantity to provide. Q* is chosen such that MR(Q*)=LMC(Q*). The market price at this quantity is given by P(Q*). (see diagram). The shaded area is the monopoly profits.

Fiscal policy (macro 4)

The government's policy on spending and taxes

Higher interest rates ii (macro 25)

The higher interest rate works by reducing aggregate demand, thereby 'cooling' off the economy.

Purchasing power parity (macro 22)

The hypothetical nominal exchange rate that makes the same 'basket of goods' in two countries cost the same. That is, it is e^ppp such that the real exchange rate is equal to 1: e^pppxp/pf=1, pr pf/p=e^ppp.

Risk free utility (micro 10)

The individual's utility if the lottery is turned down, U(100). If the lottery is accepted, utility of one of two states will be realised, U(50) or U(150). The expected utility for any value of p is shown on the (green) linear line. (see diagram). Expected utility of the gamble is the point on the green line that matches to the expected value on the horizontal axis.

What are the two margins of labour supply (micro 9)

The intensive margin reflects changes in the hours that employed workers work. The extensive margin reflects changes in the number of individuals that are employed.

Labour demand (micro 8)

The isocost curve is determined by: C=wL+rK where w is the wage for labour and r is the rental rate of capital. The slope of the isoquant is: dL/dK= -r/w. In this way we can map the relationship between the output quantity and the minimum cost of production. The competitive firm will choose the profit maximising amount of labour for its production process. This is where (assuming the firm is a price taker): PxMPL=w or MPL=w/p. This means, in a perfectly competitive goods and labour market, the last worker hired earns his/her marginal contribution to output.

Isocost (micro 4)

The isocost line shows all combinations of capital and labour that result in the same input cost.

What happens if inflation is really bad (macro 25)

The lending system can break down entirely, as lenders become unwilling to agree to nominal contracts. People want change their nominal holdings into real holdings. This leads to more inflation.

Shifting the long run Phillips curve (macro 28)

The long run Phillips curve shifts for two reasons. A permanent change in firms desired demand for workers at the current level of wage growth (for example due to a change in production technology). Structural changes in the economy that reduce the natural rate of unemployment.

Long run and short run average costs (micro 4)

The long run average cost function envelopes all short run average costs for the same production technology. (see diagram). A firm producing q2 in the short run, using the input mix reflected by A, will be better off producing using the input mix reflected by B in the long run.

The long run supply curve in a perfectly competitive market (micro 4)

The long run supply curve is determined by the market long run average costs. If all firms are identical in costs, then the LRS is horizontal at P*=LAC. If firms differ in their costs, then the LRS is upward sloping.

What is the minimum efficient scale (micro 4)

The lowest output for which LAC is at its minimum. If the total market demand for a product is 6 units, a single fireman supply the entire market at a lower average cost then two firms can.

Diminishing marginal returns to labour (micro 1)

The marginal production of labour is the extra unit of output obtained by employing one more unit of labour. When only labour is variable, law of diminishing marginal returns says that there exists an amount of labour after which every additional unit will add less to total output than the units before it. This is a short run phenomenon, it does not apply to long run production. It will apply to capital if we assume that labour is fixed and allow capital to vary.

What does the slope of the BP curve reflect (macro 23)

The mobility of capital.

The AS-AD model overview (macro 27)

The model of aggregate demand-aggregate supply is based on the following: Long run supply (and therefore output) is fixed at the economy's potential, level. In the long run inflation increases prices and wages the same. Demand side policy cannot impact the real economy in the long run. Short run supply does respond to unexpected changes in the price level. Sticky wages means that wages change slower than the price of output. Demand side policy can be a useful tool to stabilise the economy in the short run. Deviations from potential output due to supply shocks create a trade of for monetary policy. Can stabilise output or inflation, but not both.

The monopolist (micro 6)

The monopolist firm is the polar opposite of the perfectly competitive market . One firm supplies the entire market for a good. There are no direct competitors. This firm sets both the market price and quantity.

Elasticity and revenue in a monopolist structure (micro 6)

The monopolist will always price on the elastic portion of the demand curve. In the linear demand case we can easily calculate point elasticity: PED: dQ/dP x P/Q. Q=50-0.5P dQ/dP=-0.5. PED=-0.5 x 52/24= -1.08.

Opportunity cost (micro 2)

The next best alternative forgone.

Determinants of price elasticity of demand (micro 5)

The number and closeness of substitute goods. Necessities. Habit formation. Time.

The unemployment rate (macro 29)

The number of people who are without a job, but actively looking for work. Unemployment rate= unemployed/labour force.

Economic cost (micro 2)

The out of pocket expense, plus the opportunity cost.

What is the short run equilibrium in the goods market (macro 21)

The output level for which output is equal to actual AD (i.e. the 45 degree line).

Equilibrium price (micro 3)

The price at which the demand and supply schedules interest. Market clears.

What is the purpose of the ISLM (macro 21)

The purpose of the IS-LM model is to explain the short-run relationship between interest rates and output in the economy.

Supply schedule (micro 3)

The quantity if a good that sellers wish to sell at every conceivable price.

Demand schedule (micro 3)

The quantity of a good that buyers wish to purchase at evert conceivable price.

What is the money market equilibrium in the money market

The rate r* at which the supply and demand for real balances are equal.

What does the vertical line at L0 show (macro 21)

The real money supply as set by a central bank.

The reserve ratio (macro 6)

The reserve ratio is the percent of all deposits that banks keep on hand to meet withdrawals.

Shifting the Phillips curve short run (macro 28)

The short run Phillips curve can shift for two reasons. Inflation expectations change. A change in firms desired demand for workers at current level of wage growth (for example due to a change in production technology). Notice, both of these also shift the SAS curve.

Interaction of the goods market and the money market (macro 21(

The two markets influence one another through changes in r and Y. Changes in r shift the aggregate demand curve, lower rates increase firm investment and household consumption. Changes in Y shift the LL curve, higher output (income) increases the demand for real balances. There is a combination (Y*, r*) for which both markets are in equilibrium. This is the general equilibrium for the economy.

Why are there not clear adverse effects of immigration on the domestic labour force (micro 9)

The types (skill level) of workers that immigrate. Immigration can lead to the creation of new jobs.

The monetary base (macro 6)

The value of currency either in circulation or held in reserves.

Trade balance (Macro 5)

The value of net exports (X-Z).

The money supply (macro 6)

The value of the stock of all money in circulation.

Is the real economy influenced by the money supply (macro 25)

This depends on who you ask. Classical economists would say 'No'. Nominal variable only effect other nominal variables. Keynesian economists would say 'Yes'. New Keynesian economists would say 'sort of'. If the answer is 'Yes' then the quantity theory equation becomes difficult to make sense of.

The difference between accounting profits and economic profits (micro 1)

This difference is important when we talk about 'zero profits'. Zero accounting profits mean that the revenues just cover the actual money spent. Zero economic profits mean that the difference between revenues and the actual money spent is just equal to what would have been earned from the next best alternative.

The quantity theory of money (macro 6)

This is a theory that links the amount of money in the economy to inflation.

Foreign exchange market (macro 22)

This is where the currency of one country is exchanged for the currency of a different country. The price (in units of domestic currency) at which a foreign can be purchased is called the exchange rate.

The effect of monetary policy on ISLM (macro 8)

This results in a shift to the right in the LM schedule. Holding Y constant, at interest rate r*1 the money market will be in equilibrium, but the goods market will not. At the new low interest rate, increase in I and increase in C, which increases output, moving us along the LM schedule to Y*1 and r*2. The increase in the money supply lead to a decrease in interest rates, which increased private spending by households and firms.

Theory of expected utility (micro 10)

This theory states that individual's do not make risky decisions based on the expected value of these decision, but rather based on the utility the can expect to realise. Consider a lottery with two states: a good state in which wealth (W) increases by £G and a bad state in which wealth decreases by £B. If p is the probability of the good state occurring, then the expected value of the individual's wealth when the lottery is chosen is: EV=px(W+G)+(1-p)x(W-B). The expected utility of the lottery is EU(W+G,W-B;p)=pxU(W+G)+(1-p)xU(W-B). W+G is wealth in the good state. W-B is wealth in the bad state. B;p is the probability that the good state will be realised.

First degree price discrimination (micro 7)

Under first degree price discrimination, the monopolist can perfectly tell how much consumers are willing to pay and charge each a different price.

Unemployment and inflation dynamics (macro 28)

Unemployment and inflation: Consider a negative demand shock. If the central bank is targeting inflation, then the economy moves back up to A. Without inflation targeting, inflation expectations fall.

Supply shocks (permanent) (macro 28)

Unemployment and inflation: Consider a negative, permanent, supply shock. With inflation targeting (see diagram). Without inflation targeting (see diagram)

Supply shocks (temporary) (macro 28)

Unemployment and inflation: consider a positive, temporary, supply shock. Without inflation targeting we see a temporary deviation of output and unemployment. With inflation targeting we see the economy cycle away from and back to potential levels.

Frictional (search) unemployment) (macro 29)

Unemployment that arises from employees and employers taking time to find the right match.

Supply shocks with inflation targeting (macro 27)

Unforeseen temporary shocks to supply create a trade-off for the Bank. The bank has three choices: 1. Stabilise inflation. 2. Stabilise output. 3. Something in-between. Both inflation and output stabilisation objectives cannot be achieved. Stbailising inflation will induce large fluctuations in output. Stabilising output will induce large fluctuations in inflation.

Price ceilings (micro 4)

University tuition. Price caps.

The short run impact of a decrease in inflation on the Phillips curve (macro 28)

Wage contracts are based on pi0=pie. Unexpectedly low inflation, pi<pi0, means that wages are increasing faster than prices (output costs are relatively expensive). In the short run firms decrease output by cutting back on labour. Unemployment increases. U-U*= 1/b(pi-pie).

Mathematical representation of labour (micro 2)

We can assume a continuous functional form for the production process to gain some additional insight. Q=f(K0,L). Consider this production function: Q=K0L^0.5. For example, if K0=10 and L=9 then Q=30. The MPL is found by taking the first derivative with respect to labour: MPL: dQ/dL= 0.5K0L^-0.5=0.5(K0/L^0.5). The APL is found by dividing total output by the labour used: APL: Q/L= (K0L^0.5)/L = K0/L^0.5. Notice that MPL and APL are always decreasing as labour increasing.

Solving the long run total cost function mathematically

We can solve LRCF for any quantity. Slope of the isocost curve: 1L+3K=C--->L=c-3K--->dL/dK=-3. Slope of the isoquant curve: q=K^0.5L^0.5--->L(q/K^0.5)--->dL/dK=-(q/K)^2. Solving we get -(q/K)^2=-3--> K=q/square root of 3 L=square root of 3---> LTC(q)=2(square root of 3q).

Monetary policy in the classic model (macro 25)

What if pi*0 is greater than than the bank's target of pi*. If pi*0>pi* then the central bank can tighten its monetary policy (shift ii up). This increases the real interest rate at all levels of inflation. This will lead to a downward shift in the AD curve.

Optimal hours of work (micro 9)

We can think about a wage expansion path of leisure: How does consumption of leisure time change as the wage of paid labour increases. (see diagram). Notice at wages >w'' the positive income effect begins to dominate the negative substitution effect on leisure consumption.

The firm's objective (calculus) (micro 1)

We can use the tools of calculus to gain some insight on the firm's problem. maxpi(q)=TR(q)-TC(q). Remember this involves taking the first derivative and setting marginal profits equal to 0. 𝜕𝜋(𝑞) 𝜕𝑇𝑅(𝑞) 𝜕𝑇𝐶 𝑞 =−=0 𝜕𝑞 𝜕𝑞 𝜕𝑞. This means that profits are maximised where: MR(q)=MC(q).

Short run production and cost functions(micro 3)

We have written the firm's cost function as C(q)=FC+VC(q). The firm has two inputs: Capital, K, assumed to be fixed in the short run, which is rented for price r per unit. Labour, L, assumed to be variable in the short run, paid wage w per unit. So the total cost of production for the firm will be: C=rxK0+wxL.

If the slope of BP> slope of LM what is capital mobility (macro 23)

We say capital mobility is low.

If the slope of the BP< slope of LM what is capital mobility (macro 23)

We say that capital mobility is high.

Profits from collusion (micro 7)

What are the maximum profits that can be made by all firms in an industry. Maximum profits are equal to what would be made by the monopolist firm. Two (or more) firms can cooperate, fixing the aggregate output of a good at the monopolist level. Each firm provides the predetermined amount (of the monopolist quantity) to the market. The colluding firms provide a total of Qm to the market at price Pm. Each firm earns pi=qxPm where the sum of q=Qm (see diagram)

Price changes and expenditure changes (micro

What happens to total expenditure (i.e. revenue to firms) following a price increase? The expenditure change can be decomposed into two parts: 1. Expenditure decreases as the quantity purchased decreases. 2. Expenditures increase as the price per unit increases. The effect on total expenditure will depend on which one of these is larger. The size of each component change will depend on: a). The slope of the demand curve. b). Position on the demand curve.

Insurance (micro 10)

What if the gamble cannot be avoided? Consider a farmer growing okra. There is a 50% chance that it will rain enough to produce a crop, in which case the farmer's wealth will be £500. If it does not rain enough, no crop is produced and the farmer's income will be £100. How can the farmer reduce risk exposure. The farmer's expected utility is equal to utility at £175 with certainty. (see diagram). The farmer will accept any guaranteed wealth greater than £175 to eliminate the risk. The difference between the expected value and this amount is the risk premium: Risk premium=300-175=125. The farmer is willing to pay to reduce risk exposure. How can this be accomplished. The farmer is friends with an actor who also earns £500 with p=0.5 and £100. Assume that the hisk exposure between the two individuals is uncorrelated. The farmer says to the actor: let's combine our incomes and each take half regardless of the realised state of the world. (see table). The expected value of each individual's income has not changed: EV=0.25x500+0.5x300+0.25x100=300. However, it is easy to show that: Expected utility with pooling 0.25xU(500)+0.5xU(300)+0.25xU(100) is greater than expected utility without pooling 0.5xU(500)+0.5xU(100).

Financial panic (macro 6)

When a large number of depositors wish to withdraw their deposits simultaneously.

Liquidity crisis (macro 6)

When an institution is temporarily unable to meet immediate payment requests.

Solvency crisis (macro 6)

When an institutions assets have become less than its liabilities.

Currency appreciation (macro 23)

When domestic currency is appreciating, e increasing, imports are becoming cheap relative to domestic goods, foreigners find exports relatively expensive. All else equal: When the domestic currency appreciates the IS curve shifts left.

Where is the cost minimising choice of inputs for a given level of production found (micro 4)

Where the isocost line is just tangent to the isoquant. This shows the lowest cost input combinations for the desired output. Solving mathematically: Note the point of tangency is where the slope of the two curves are equal. Slope of the isocost curve : 1L+3K=C--->L=C-3K--->dL/dK=-3. Slope fot the sioquant curve: 100=K^0.5L^0.5--->L=(100/K^0.5)^2--->dL/dK=-(100/K)^2. Solving we get: -(100/K)^2=-3--->L=57.7 L=173.2.

A linear demand curve (micro 1)

With a linear demand curve, total revenue is maximised at the q that is half way to the point of intersection on the horizontal axis. For example P(q)=10-0.5q. This curve cuts the x axis (P=0_ at q=20. Half way therefore q=10. Notice that this is the point on the demand curve where elasticity is equal to 1.

Oligopoly equilibrium (micro 8)

each firm has the incentive to deviate from the monopoly provision level. This deviation will take place until the marginal gain from increasing quantity is less than the marginal loss of a price reduction. The equilibrium will be where the marginal gain from one firm increasing quantity is less than the marginal loss of a price reduction. Therefore we know the following piM>pi0>pic. The oligopoly equilibrium will move closer to the competitive equilibrium as the number of firms increases. With many firms each having a small market share, increasing the quantity of an individual firm has little influence on the price. A key thing to note with the oligopoly equilibrium is that all firms in the market will make more profits if they collude and produce the monopolistic quantity. Because each firm is acting in its own self interest, collusion in a free market is inherently unstable. Because they cannot creditably collude, in equilibrium all firms earn less profits. This is a classic (and very important) result in game theory, that we refer to as a Nash-equilibrium.

Brining together the firm's profit maximisation problem with the firm's production technology (micro 3)

pi(Q)=P(q)xq-C(q)

How does the short run cost function relate to the profit function (micro 3)

pi(Q)=P(q)xq-C(q). Prices are determined by the market demand the firm faces. Costs are determined by the productivity of inputs that the firm uses. The firm's production function captures the demand and technology constraints faced by the firm.

What shifts the SAS curve (macro 27)

pi= pie+𝜃(Y-Y*)+p 1. A change in the inflation expectations, pie. 2. A supply shock.

Solving for the isoquant with Cobb Douglas technology (micro 4)

q(K,L)= 𝐾𝛼𝐿𝛽. Choose a fixed output level (for example ത = 100) 𝑞ത = 𝐾 𝛼 𝐿 𝛽 Now solve for 𝐿: L= (𝑞ത/𝐾𝛼)^1/𝛽. (symbols are not correct).