Macroeconomics Final Exam
reserve requirements
rules set by the Federal Reserve that determine the minimum reserve ratio for a bank.
Medium of exchange
something people accept as payment for goods and services (an asset that individuals acquire for the purpose of trading rather than for their own consumption)
Implicit liabilties
spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics
Reserve ratio
the fraction of bank deposits that a bank holds as reserves (reserves/deposits)
federal funds rate
the interest rate determined in the federal funds market
If the tax is not a lump-sum tax, the tax revenue will depend on:
the level of real GDP (and reduce the size of the multiplier)
Potential output
the level of real GDP the economy would produce if all prices, including nominal wages, were fully flexible
discount rate
the rate of interest the federal reserve charges on loans to banks normally this is set 1 percent more than the federal funds rate to discourage banks from turning to the feds when they are in need of reserves
monetary base
the sum of currency in circulation and bank reserves
Debt
the sum of money a government owes at a particular time
Planned aggregate spending =
the total amount of planned spending in the economy. C + Planned Investment
money supply
the total value of financial assets in the economy that are considered money currency in circulation + checkable bank deposits
Fractional reserve banking system
when you deposit money in a bank account, the bank is required to hold a part of it in its vault as cash, or else in an account with the regional federal reserve bank. They use the rest of the money to make loans.
What causes the SRAS curve to shift right?
Decrease in commodity prices Decrease in nominal wages Increase in productivity Each of these increases producers' profits and shifts the curve right
bank run
a phenomenon in which many of a bank's depositors try to withdraw their funds because they fear a bank failure. contagious
t-account
a tool for analyzing a business's financial position by showing their assets and liabilities
federal funds market
allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves
discount window
an arrangement in which the federal reserve stands ready to lend money to banks in trouble
M2
includes near-moneys
M1
includes only the most liquid forms of money
A fall in the aggregate price level of the LRAS...
leaves the quantity of the aggregate output supplied unchanged in the long run. The price level in the long run does not affect the aggregate output supplied.
Unit of account
money provides a yardstick for measuring and comparing the values of a wide variety of goods and services
Fiat money
money whose value derives entirely from its official status as a means of payment
capital requirements
requirement that the owners of banks hold substantially more assets than the value of bank deposits
What does a movement down the aggregate demand curve lead to?
A lower aggregate price and higher aggregate output
Lump-sum taxes
Taxes that don't depend on the taxpayer's income
Output gap
The % difference between actual aggregate output and potential output
Total increase in GDP calculation
(1 / 1-MPC ) x (amount of increase in investment spending)
Output gap formula:
(Actual - potential) / potential all times 100
Assumptions for the income-expenditure model
- Changes in overall spending lead to changes in aggregate output - The interest rate is fixed - Taxes, government transfers, and government purchases are all zero - Exports and imports are both zero
What drives planned investment spending?
1. The interest rate 2. Expected future real GDP 3. Current level of production capacity
Keynesian cross diagram
A diagram that identifies income-expenditure equilibrium as the point where a planned aggregate spending line crosses the 45 degree line
Interest rate effect
A higher aggregate price level makes households hold more money and leads to a rise in interest rates (and a fall in investment spending and consumer spending)
Wealth effect
A higher aggregate price level reduces the purchasing power of households' wealth and reduces consumer spending
Accelerator principle
A higher rate of growth in real GDP leads to higher planned investment spending. A lower growth rate of real GDP leads to lower planned investment spending.
The multiplier
A multiplier shows how initial changes in spending lead to further changes. It helps us understand chain reactions and how much extra income and spending are created from a initial change in spending. 1/(1-MPC) OR ΔY/ΔAAS
Income-expenditure equilibrium
Aggregate output (real GDP) is equal to planned aggregate spending
Consumption function
An equation showing how an individual household's consumer spending varies with the household's disposable income. c = a + MPC x yd c = household consumer spending a = constant, autonomous consumer spending yd = household's disposable income
Cyclically adjusted budget balance
An estimate of the budget balance if the economy were at potential output This is used to separate the effects of the business cycle from the effects of discretionary fiscal policy
ΔAAS
Autonomous change in aggregate spending.
Why does the SRAS curve slope upward?
Because nominal wages are sticky in the short run.
Aggregate consumption formula
C = A + MPC x YD
ΔY
Change in Real GDP (1/1-MPC) x ΔAAS
2 possible sources of a shift of the planned aggregate spending line
Change in interest rate and change in wealth
What causes shifts of the aggregate consumption function?
Changes in expected future disposable income and changes in aggregate wealth
What causes the SRAS curve to shift?
Changes in: Commodity prices, nominal wages, and productivity Each of these factors changes producers' profits and therefore shifts the SRAS
Does a change in wealth move us along the aggregate demand curve or shift it by the wealth effect?
Depends on the source of the change in wealth. Change in price level: movement along Change in something else: shift
The aggregate demand curve shifts because of changes in:
Expectations, wealth, size of the existing stock of physical capital, and government policies (monetary and fiscal)
Contractionary fiscal policy
Fiscal policy that decreases aggregate demand - brakes for the economy ex: reduction in government purchases of goods and services, increase in taxes, and reduction in government transfers Can close an inflationary gap
Expansionary fiscal policy
Fiscal policy that increases aggregate demand - extra fuel for the economy ex: Increase in government purchases of goods and services, cut in taxes, and increase in government transfers Can close a recessionary gap
Social insurance programs
Government programs (transfer payments) intended to protect families against economic hardship Ex: medicare
Marginal propensity to consume (MPC)
How much consumers spend when they receive more income. Change in consumer spending / Change in disposable income
Holding everything else constant, the multiplier effect for taxes or transfers:
I smaller than the multiplier effect for changes in autonomous aggregate spending
What happens when there is a shock on the economy?
If a demand or supply shock hits the economy, aggregate demand or SRAS shifts and moves the economy to a new short-run equilibrium
Aggregate demand curve
Illustrates the relationship between the aggregate price level and the quantity of aggregate output demanded in the economy
Aggregate supply curve
Illustrates the relationship between the aggregate price level and the quantity of aggregate output supplied in the economy
Current disposable income
Income after taxes are paid and government transfers are received
What causes the SRAS curve to shift left?
Increase in commodity prices Increase in nominal wages Decline in productivity Each of these decreases the producer's profits
Who introduced the multiplier idea?
John Meynard Keynes
Change in consumer spending =
MPC x change in disposable income
Store of value
Money is a means of holding purchasing power over time - enables people to save the money they earn today and use it to buy the goods they want tomorrow
Stick wage:
Nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labor shortages
Government transfers
Payments by the government to households for which no good or service is provided in return
Aggregate consumption function
Shows how current disposable income affects consumer spending. Relationship for the economy as a whole between aggregate disposable income and aggregate consumer spending.
Long run aggregate supply curve
Shows the relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages, were fully flexible.
Holding everything else constant in an economy, the larger the MPS, the: _____ the value of the multiplier
Smaller.
Government saving (Surplus) =
Tax revenues - government purchases - transfers
Stagflation
The combination of inflation and falling aggregate output that comes with a negative supply shock
What is planned investment spending?
The investment spending that businesses intend to undertake during a given period
Income-expenditure equilibrium GDP:
The level of real GDP at which real GDP equals planned aggregate spending
Actual investment spending
The sum of planned investment spending and unplanned inventory investment
What is "long run" referred to?
The time it takes for all prices (including nominal wages) to adjust. However, there is not a change to profits just because prices have changed.
Stabilization policy
The use of government policy to reduce the severity of recessions and rein in excessively strong expansions
Fiscal policy
The use of taxes, government transfers, or government purchases of goods and services to shift the aggregate demand curve. Ex: Tax cuts
Inventory investment
The value of the change in total inventories held in the economy during a given period
What can we look at to explain and predict the economy's behavior? (ex: recessions, inflations)
Total (aggregate) demand and total (aggregate) supply
Unplanned inventory investment
Unplanned changes in inventories occurring when actual sales are more or less than businesses expected
AD-AS model
Uses the aggregate supply curve and the aggregate demand curve together to analyze economic fluctuations
Why does a rise in the aggregate price level reduce consumer spending, investment spending and exports minus imports? (Why does the AD curve slope downward?)
Wealth effect and the interest rate effect
Marginal propensity to save (MPS)
Whatever is not spend with the MPC is saved. The fraction of an additional dollar of disposable income that is saved. MPS = 1 - MPC
Inflationary gap
When aggregate output is above potential output
Recessionary gap
When aggregate output is below potential output
Long-run macroeconomic equilibrium
When the point of short-run macroeconomic equilibrium is on the long-run aggregate supply curve
What levels of GDP is unplanned inventory investment positive?
Wherever GDP is greater than aggregate spending planned
excess reserves
a bank's reserves over and above its required reserves (we assume banks don't want to hold excess reserves)
federal reserve
a central bank that oversees and regulates the banking system and controls the monetary base
demand deposits
a deposit of money that can be withdrawn without prior notice
Commodity money
a good used as a medium of exchange that has intrinsic value in other uses ex: cigarettes in prison
deposit insurance
a guarantee that a bank's depositors will be paid even if the bank can't come up with the funds. (the FDIC currently guarantees the first 250,000 of each account)
Commodity-backed money
a medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods
Money must function as:
a medium of exchange, a store of value, and a unit of account
Monetary aggregate
an overall measure of the money supply
Discretionary fiscal policy
arises from deliberate actions by policy makers rather than rules
checkable bank deposits
bank accounts on which people can write checks
open-market operations
buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system, facilitated by the federal reserve
currency in circulation
cash held by the public
A movement down the short-run aggregate supply curve leads to:
deflation and lower aggregate output
why does the money multiplier decrease when you increase the percentage of bank deposits?
ex: bank deposits = 1000 if original percentage is 10, then the amount of bank deposits requires is 100. this means the money multiplier is (1000/100) if increased to 20, amount of bank deposits required is 200. this means money multiplier is (1000/200 = 5) <-- decrease
near moneys
financial assets that cant be directly used as a medium of exchange but can readily be converted into cash or checkable bank deposits
What commodity does the Federal Reserve choose to buy and sell daily?
government bonds, because they can be stored indefinitely and are easy to buy and sell on the open market Usually buys and sells short-term bonds called Treasury bills, or T-bills
Automatic stabilizers
government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands (unemployment insurance)
what is used to determine the money supply?
not only on the ratio of reserves to bank deposits but also on the fraction of the money supply that individuals choose to hold in the form of currency
Holding everything else constant, the government's deficit
tends to increase during a recession and will increase if the government purses expansionary fiscal policy
money multiplier
the amount of money that banks generate with each dollar of reserves formula = (bank deposits/amount of required reserve) ratio of the money supply to the monetary base
bank reserves
the currency that banks hold in their vaults plus their deposits at the Federal Reserve
Deficit
the difference between the amount of money a government spends and the amount it receives in taxes over a given period
Nominal wage:
the dollar amount of the wage paid
