Econ 116 final
Why was the economy strong in the 90s?
booming stock market, real wealth effect
How does the US usually respond when the current account does not equal 0?
borrowing money abroad
Say that g* increases, what effect does this have on I? Trace through the effects
*** g* increases, the AD curve moves to the right, so Y* and P* increase. r* increases, because according to the fed rule, r increases when Y or P increase, and both increased in this situation. domestic currency appreciates, according to the exchange rate equation. domestic exports decrease because they are relatively more expensive now since the domestic currency appreciated. According to the GDP equation, Y (GDP) decreases when exports decrease. Falling Y triggers an increase in r, per the fed rule. when r increases, it crowds out investment. I decreases when g* increases
Say that PM∗ increases (but PM doesn't). Assume that the exchange rate equation is in (not dropped). Assume that the interest rate is not at the zero lower bound. What effect does the PM∗ increase have on P∗, r∗, Y∗, and C∗? Is it likely that the dollar will appreciate or depreciate relative to the U.K. pound? Explain.
***a PM* increase causes the AS* curve to shift to the left, so P* increases and Y* decreases. The fed rule* kicks in to fight the inflation, so r* increases. C* decreases in response to r* increasing (higher opp cost to consume now). the higher r* will make England have more profitable securities to invest in, so this increases the demand for pounds, so the pound appreciates. Also, because PM* increase in price, English goods are more attractive by comparison, so demand for English goods increases, so demand for pounds increases, so the pound appreciates. In addition, P* increases, PEX* increases, PIM increases, AS curve shifts left, P increases, Y decreases, fed rule is more concerned about P so r increases. as a result, you have to make certain assumptions to say whether the price effect or interest rate effect has a larger effect on e.
Cobb-Douglas .3 capital and .7 labor: if the growth rate of capital increases by 2% how is the growth rate of output affected? what if instead human capital increases by 2%?
.3 * .02 increase .7*.02 increase
3 Okun's Law Leakages/Slipages
1. change in the number of jobs does not change as much as change in output - employers meet some of the increased demand by having workers work more - a firm holding excess labor will use it to meet the increased demand 2. change in number of employed persons does not change as much as change in jobs does - some people have more than one job 3. change in labor force size does not change as much as output does - discouraged workers cause the unemployment rate to improve slower than would be expected in a recovery
factors to consider when evaluating whether the price level effect or interest rate effect is dominant?
1. import/export level in a country 2. investment level
How would the Japanese Central Bank's decision to buy large amounts of stocks from the biggest Japanese companies improve economic growth in Japan?
1. it could increase consumer confidence. When Japanese consumers see the drastic measures the government is willing to avoid recession, Japanese consumers are more likely to spend money now (higher MPC). 2. Buying these stocks will cause them to become more valuable, so Japanese stockholders will earn higher returns, and have more income, so GDP rises.
If the US added an unexpectedly high number of jobs, why does the euro depreciate?
A surprising increase in the number of jobs is good news for the US economy, so the Fed becomes more likely to raise interest rates, as it is less concerned about output, and more concerned about combatting inflation. Expecting the interest rate to increase, Financial institutions will now increase the amount of dollars they hold, so they can invest in relatively more lucrative US securities. The euro will depreciate relative to the dollar because demand for the dollar has increased; institutions will exchange euros for dollars.
How can China screw over the US, and how can the US screw over China?
China can sell all its USD, causing the dollar to plummet in value; the US can depreciate its currency, causing the USD China holds to lose their value
How has China accumulated so many USD?
China has a large trade surplus with the US, so there are a lot of Americans looking to exchange their dollars so they can buy Chinese goods. The Chinese central bank is the only supplier of yuan, so American businesses give the Chinese central bank dollars for yuan. Also, foreign firms are not allowed to buy many Chinese securities. WhOver time, the Chinese central bank has accumulated a lot of USD, so, they may as well earn interest on it, so they safely invest it in US bonds.
What is the difference between embodied technical change and disembodied technical change? Give an example of each.
Embodied technical change results in an improvement in the quality of capital: this happens when technical innovations are incorporated into new machines, with older machines discarded when they become obsolete. Disembodied technical change is not specifically embedded in either labor or capital, but results in a change in the production process. One example could be changes in regulations that affect the production process and thus the productivity of the firms.
What other variables affect consumption besides Yd?
Expected future income is important. According to the simple life cycle model, people will try to spread their earnings over their life time. In addition, the interest rate affects consumption as well; the opportunity cost of spending money now is higher when the interest rate is higher.
Two examples where ignoring expectations would lead to an incorrect view of how the economy works
Firms use expected future output to determine how much capital and workers they maintain. For instance, ignoring expectations, one would not expect firms to keep extra workers after a rough quarter, but perhaps the company knows that they will need all hands on deck for the Christmas shopping season Expectations are also important in determining the Fed's interest rate, represented by the Z variable in the Fed rule. The Fed monitors inflation expectations, consumer confidence and other measures about where people think the economy is going and then lean against the wind. Someone who ignores expectations may be shocked when the Fed decides to not raise the interest rate, but this decision may be obvious if one had just looked at the abysmal consumer confidence.
Why might investment depend on output as well as the interest rate?
Firms will invest (buy machines, buildings, etc.) if they expect to increase production due to future increases in sales. When output increases, this also means that income increases, which in turn means that consumption, and thus sales, will increase as well. If this increase in output is expected to be permanent, firms will invest more since they want to increase future production.
The unemployment rate generally fluctuates less than output. What are the three main reasons for this?
First, as described above, the number of jobs does not closely follow output since there are costs associated with hiring and firing workers. Instead, the firm may increase hours worked for workers currently employed at the firm when there's a temporary increase in output. Or if the firm has excess labor it can utilize this excess labor first before needing to hire new workers. Second, there's a difference between the number of jobs available and the number of people employed since some workers may hold more than one job. Therefore, when the number of jobs increases, some workers that are currently employed acquire additional jobs, and when this happens, the unemployment rate does not decrease. The third reason is the discouraged worker effect. When output is high, times are good, so workers who were previously discouraged may start looking for a job, increasing the unemployment rate in good times, or at least stopping the unemployment rate from falling as much as we might expect.
If a US citizen sells his two year old NYC condo to a Russian for rubles, does this count as an American export and a Russian import? How is the US current and capital accounts affected?
No. It's treated as if the Russian person bought a power plant in the U.S. Only the asset side of the capital account is affected, because the U.S. holds more rubles (asset), but lost the condo (asset). The result would be different if the Russian rented the condo, which would be treated as an American export of rental services.
In what sense is fiscal policy possibly less effective under flexible exchange rates than under fixed exchange rates? What about monetary policy?
Fiscal policy is less effective. In the AS/AD model, an increase in fiscal spending (G) causes the AD curve to shift right, which leads to an increase in the general price level (P), which, according to the Fed rule, will lead to an increase in the interest rate (r). The higher interest rate will likely lead to an appreciation of the currency under flexible exchange rate, which according to the theory will worsen the trade balance. Monetary policy is more effective. Suppose there is high inflation and the Fed raises the interest rate. In the basic model, Investment decreases, Y decreases, which in turn leads to a decrease in C and a multiplied decrease in output. The decrease in AD lowers P. With flexible exchange rates, there is an additional effect. The value of the dollar relative to foreign currencies increases; exports become more expensive and imports become cheaper. As exports fall and imports rise, Y decreases further. As AD falls further, there is a greater drop in price. This makes monetary policy more effective.
Say the fed rule calls for an increase in r as a result of an increase in Z. How does the size of the effect on output, Y, depend on the size of h, the coefficient on r in the investment equation?
Here, you simply have to explain the AD curve. I=d-h×r. When r increases, I decreases, but how much I decreases is determined by the coefficient h. In turn, when I decreases, Y also decreases. So Y also depends on the coefficient h.
China holds over a trillion dollars of US debt, mostly in short term securities. If the dollar were to depreciate relative to the euro, how would this affect China, assuming that the depreciation did not cause inflation in the US? How would China be affected if there were also inflation in the US?
If there is no inflation in the U.S., change in the dollar-euro exchange rate will not have any effect on China's import/export with the U.S. However, if there is inflation in the U.S. (which we can expect because of higher import prices from Europe), then this will affect the dollar-yuan exchange rate, i.e. yuan appreciates against the dollar. This will hurt China's exports and increase China's imports, which is bad for the Chinese economy.
Why would a large increase in inventory investment one quarter possibly be bad news for future output? How does this relate to adjustment-to-equilibrium?
If this large increase in inventory investment is unexpected, then that means that firms sold far fewer goods than expected. In the future, they are likely to adjust accordingly, and produce fewer goods, as firms in general aspire to produce exactly as many goods to sell as necessary. output is poised to drop next quarter.
What, besides income, explains the demand for imports?
Imports are another form of consumption, and as such is affected by the same income (or wealth) and substitution effects. When wealth increases (e.g. an appreciation of housing, bond, or stock prices), the demand for income will likely increase, under a life-cycle theory of consumption. When the relative price of domestic goods increases, or the relative price of imports falls, we would also expect consumers to substitute away from the relatively higher-priced domestic goods, increasing demand for imports. Exchange rates may also affect the demand for imports by affecting the price, but we will dive deeper into that analysis next week.
Is the interest rate that appears in the denominator of every term in the expression that represents an asset's value (bonds, stocks, etc.) the same interest rate that is determined by the Fed? Or is the interest rate that appears in the denominator of every term in the summation that represents a bond's value, for example, a different interest rate that is stipulated by the terms of agreement in the bond contract?
In case of asset valuation, the "interest rate" that appears in the denominator is more accurately described as the discount rate. The discount rate depends on the prevailing interest rate for debt obligations with similar risks and maturities. So the answer lies somewhere in between: it is not the same for all assets, but it is not necessarily specific to each asset, either. Determining the discount rate is a science of its own, but you should understand that the interest rate on U.S. Treasury bonds, which serves as the baseline risk-free rate, ultimately affects other interest rates.
In practice an increase in the price level has negative effect on consumption (contrary to the standard AS/AD model). Why?
In the extended model, consumers do not make consumption discussions in isolation from their labor force decisions. Labor force variables like the real wage rate affect consumption. An increase in the price level reduces the real wage rate. In the labor market, individuals have the choice of working or seeking leisure, which is a positive good. A reduction in the real wage rate has a positive substitution effect on leisure because the implicit price of leisure goes down and households will work less. A decrease in the real wage rate has a negative income effect on leisure and should lead households to work more. We assume that the substitution effect dominates and so a reduction in the real wage rate reduces the hours of work, which in turn reduces household income. The reduction in household income reduces consumption. Also, under the Fed Rule, increase in price level leads to increase in interest rates.
Why would long term interest rates go down if the Fed raises the interest rate but is lukewarm about future raises?
Normally, you'd expect that if the Fed increases the interest rate, the long-term interest rate will also increase, as explained by the term structure of interest rates. But if the long-term interest rate decreases, it can mean that (1) the Fed increased the interest rate by less than expected, and/or (2) the long-term economic forecast has gone down despite the Fed's increase. So, for example, if the Fed's announcement included some cautious language about the economy, maybe signaling that it is not likely to raise interest rates in the year after, then it makes sense that the long-term interest rates could have gone down despite the announcement.
What is the shape of the AD curve if beta, P's coefficient in the fed rule, is 0? In this case, what is the effect on consumption if the price of imports suddenly increases?
Now, interest rate (which is determined by the Fed Rule) does not depend on P. It only responds to changes in Y and Z. This means that the level of investment (which is determined by r) does not depend on P, and by extension, Y does not depend on P. Therefore, the AD curve becomes vertical. If we assume the closed economy model, increase in PM will increase P, and the AS curve will shift left. However, P does not affect r, so AD curve does not shift. The result is an increase in P, but no change in Y. As an exercise, think about how the result might be different if we were talking about an open economy.
Why is productivity pro cyclical?
Productivity is output per worker. Output changes by proportionately more than employment. In boom periods, output proportionately increases by more than employment and so productivity increases. In recessions, output proportionately decreases by more than employment and so productivity increases. Thus productivity is pro-cyclical.
What are two reasons outside the AS/AD model that a price shock can reduce consumption?
Real wage effect and real wealth effect. Under the AS/AD model, consumption is determined by disposable income (Keynesian theory). Outside the AS/AD model, we can consider interest rate, life-cycle income, etc
Why do some say that the measured unemployment rate is too high?
Some people are unemployed because they are overestimating how much they should be paid. They could find a lower paying job, but they keep looking for something better. This is more common for certain sectors hit hard by globalization, like the auto industry.
Is the Laffar model consistent with microeconomic theory? why?
The Labor supply moves with changes in tax rates for two reasons: 1. Substitution effect: when t increases, relative value of working goes down causing a decrease in labor supply 2. Income effect: when t increases, income decreases so there is an increase in the labor supply.
What are the policy properties of the Lucas supply function model if people do not have rational expectations?
The Lucas supply function in combination with the assumption that expectations are rational implies that anticipated policy changes have no effect on real output, since what matters for output in the Lucas framework is the difference between actual price level and expected price level, and if expectations are rational, anticipated policy changes change expectations just as much as they change the actual price level. If expectations are adaptive, and so people expect the price level to be what it was before, then an increase in money supply will raise the actual price level more than the expected price level and so will result in an increase in output given the Lucas supply function.
What happens to a country's capital account if its current account is balanced? Explain.
The capital account balance should be zero. This is because the balance on the capital account when added to the current account balance should be zero.
If the US economy continues to expand, say driven by the real wealth effect on an increase in housing prices and stock prices, what would be the affect on the current account deficit and government budget deficit?
The current account deficit increases as US GDP increases, primarily as a result of the increasing trade deficit which results from a booming US economy. The Fed will increase the interest rate, so demand for US securities increases, so demand for USD increases, so the USD appreciates, so the price of imports are relatively cheaper, and the price of US exports are more expensive for other countries to buy, so the US imports more and exports less, so the trade deficit increases, so the current account deficit increases. The government deficit decreases, because when GDP increases, taxable income increases, so tax revenue increases, so the government deficit decreases.
What is the effect of decreased g on the current account deficit and the government budget deficit.
The current account deficit will decrease, because the Fed will decrease the interest rate, so demand for US securities decreases, so demand for USD decreases, so the USD depreciates, so the price of imports are relatively more expensive, and the price of US exports are cheaper for other countries to buy, so the US imports less and exports more, so the trade deficit decreases, so the current account deficit decreases. The government budget deficit will decrease because spending has decreased
According to the J-curve effect, a depreciation of a country's currency initially leads to a fall in its current account. Explain how this initial effect can occur. What happens to the current account over time?
The current account initially falls because the balance of trade initially falls. When the price of, say, dollars falls, imports become more expensive, because one USD buys fewer euro, yen, etc. Over time, (depending on how elastic import and export demand is), import quantities decreases, and export quantities increase, which causes the trade deficit, and by extension the current account deficit, to improve
Why could you argue that there is still equilibrium in the labor market even when the unemployment rate is high?
The economy is dynamic, with several different sectors expanding and contracting. Sometimes, people overestimate how much their market worth is, and reject decent jobs because they believe they can find a better paying job later.
How is the size of the government spending multiplier in a country affected by the marginal propensity to import in other countries? Assume an open economy but fixed exchange rates.
The government spending multiplier in country A increases as the marginal propensity to import increases in country B. G increases, EX increases, Y* increases, IM* increases, EX increases
When exchange rates are flexible, and the Fed raises the interest rate, what effect does this have on the price level and why? How does the size of the effect change if the exchange rate is fixed instead?
The higher interest rate makes investing in US securities more lucrative, so the demand for USD increases, so the USD appreciates relative to other currencies. The higher price of USD reduces the price of imports, shifting the AS curve to the right, reducing inflation. The Fed is less effective at fighting inflation when exchange rates are fixed. Regardless, when r increases, planned investment decreases, consumption spending decreases, output decreases, so the price level decreases.
say that Z* increases. What effect does this have on e and P?
The key is to consider the first-order effects. First, run through what happens in the other country. When Z* increases, r* increases, I* decreases, and Y* decreases. As AD* shifts, P* also decreases. Second, consider how this is connected to the U.S. As r* increases and P* decreases, e decreases. As Y* decreases, IM* also decreases, which means EX decreases. But this is offset by the fact that e decreases as well: EX =1/e IM^*. Finally, see how these changes affect the U.S. Here, you will have to make some assumptions and justify them. For instance, we assume that the expansionary effect of lower e outweighs the contractionary effect of lower EX, as explained above. As e decreases, both PM and Y increases. This means P increases.
How can the number of unemployed people increase, payroll employment increase, yet the unemployment rate remain unchanged.
The labor force has merely increased, and the number of jobs has increased so that the percentage of new workers with jobs is proportional to the existing unemployment rate; therefore, the new unemployment rate is unchanged, even though there are more unemployed persons, and more employed persons.
What assumptions are needed in order for the quantity theory of money to hold? Are these assumptions realistic?
The main assumption of the quantity theory of money is that the velocity of money is constant. The equation of the quantity theory of money is: M × V = P × Y and implies that the demand for money depends on nominal income (P × Y), but not on the interest rate. This is in sharp contrast with the AS-AD model, where the demand for money does depend on the interest rate.
What is the Price Feedback Effect and how does it explain the 1970s?
The price feedback effect is the process by which a domestic price increase in one country feeds back on itself through export and import prices. A rise in the price level in one country drives up the price of exports and so the price of imports for its trading partners, shifting up their AS curve, raising prices. Households in these countries will also tend to substitute domestically produced goods for imports, and this is equivalent to a rightward shift of the aggregate demand curve. These shifts in demand and supply will cause prices in this second country to rise, including prices of exports, which in turn will increase the price of imports in the first country, as well as the overall price level. In the 1970s, we saw a large increase in oil prices, which is an increase in the price of imports for all oil-importing countries. This supply shock drives up the price level and reduces output. The increase in the price level is reflected in the price of exports, which then affects all other countries, including oil-producing ones
what does it mean to say that someone has rational expectations about inflation two years from now?
The rational expectations model assumes that (1) there is a correct model of the economy, and (2) all economic agents know and act according to this model. This means that fluctuations in output will be caused only by something that was unexpected. In the Lucas supply function, this "surprise" comes from the deviation of the P from expected P. In the Real Business Cycle (RBC) model, the "surprise" is usually an exogenous shock relating to technology (i.e. productivity). So under the model, this exogenous shock is the only thing that can lead to fluctuations in output. It is worth noting that the "Real" in RBC means that there is no role for money or "nominal" variables.
How is the US able to maintain its current account deficit while increasing its holding of foreign assets?
The reason that US is able to run current account deficit while increases its holding of foreign assets is that it is able to increase foreign liabilities at the same time. For example, countries around the world have accumulated large amounts of US treasury bonds in recent years, and these foreign purchases are foreign liabilities on US's cross-border balance sheet. The availability of such capital inflows allows US to purchase foreign assets, despite its current account deficit.
What is the Trade Feedback Effect?
The trade feedback effect is the tendency for an increase in the economic activity of one country to lead a worldwide increase in economic activity, which than feeds back to that country. Assume there is an expansionary fiscal policy, so G increases. This leads to an increase in planned expenditure on Y, C and imports. This corresponds to an increase in the rest of the world exports, which gives a boost to income in the foreign countries, which increases the foreign demand and foreign imports. This translates into an increase in domestic exports and so into an additional increase in income. Therefore the presence of trading partners makes the spending multiplier bigger because for a given initial increase in G there is a bigger increase in Y
Why if there is a surprisingly positive employment announcement, long term bond prices will immediately fall? The effect on stock prices, on the other hand, is ambiguous. Why?
This surprising positive employment announcement means that the Fed is more likely to raise the interest rate in response to the improving economy. A higher interest means that bond price decreases, because the previously issued bonds are in less demand, because the new bonds have a higher interest rate, so the price must be lowered of the previous bonds for anyone to buy them The effect on stock prices is ambiguous, because the present value of the stocks may decrease because of the higher interest rate, but stocks may increase because, the economy appears to be improving, so future dividends are expected to be higher.
What explains the demand for US exports?
U.S exports are the imports for other countries. Thus demand for U.S. exports are determined by economic activity in the rest of the world—rest of the world real wages, wealth, non labor income, interest rates etc.
You are 40 years old, and expect to live to 90. In a total surprise, you will receive a 1 million USD inheritance in 20 years. Under the Keynesian Consumption model how much should you increase your consumption this year? How much should you increase your consumption this year under the simple life cycle theory model? Will your lifetime labor supply change?
Under the Keynesian Consumption model, consumption will not increase this year, because future expectations are ignored in favor of only looking at current income. Under the simple life cycle theory model, consumption will increase by 20,000, as the one million will be spread equally over 50 years. you will work less over your lifetime
Why did the unemployment rate increase from 2007 to 2009?
Unemployment rate is inversely related to output, so the question is essentially asking why output decreased from 2007 to 2009. The conventional story is that housing market burst, which meant that people had lower wealth. And through the wealth effect, consumption decreased, which lowered output.
Why are bond prices and interest rates inversely related?
When the interest rate rises, bonds already issued become less attractive by comparison, so these bond prices must decrease for anyone to be willing to buy them.
Why is the PPP theory of exchange rate determination quite accurate when there is hyperinflation? What would happen during hyperinflation if the country's exchange rate was fixed?
When there is hyperinflation, price levels skyrocket. So a loaf of bread might cost $1 billion in the U.S., for example. PPP theory suggests that if the loaf of bread costs €1 in Europe, the exchange rate will be set such that $1 billion = €1. This is consistent with what we observe in practice, which is that countries that experience hyperinflation also see their currencies plummet in value. If the exchange rate was fixed instead (let's say at $1 = €1), everyone will want to purchase things in euros instead of U.S. dollars. After all, why buy a loaf of bread for $1 billion if you can exchange your money to €1 billion and buy 1 billion loaves from Europe? The problem, of course, is that as demand for euros increases, it would be difficult to keep the exchange rate fixed. The government has to supply the euros itself, but it is going to run out of euros at some point. So it is almost impossible for the government to keep the exchange rate fixed during hyperinflation.
how does a stock market boom affect the current account deficit?
a stock market boom means that wealth increases, so disposable income increases, so consumption increases. If a nation imports more than it exports, then the current account deficit will exacerbate this. Also, price levels tend to increase when output increases, which makes imported goods cheaper by comparison. Consequently, domestic consumers will buy more imports. The current account deficit increases when the trade deficit increases
. List the following transactions in the current account and capital account of the United States. Denote under which category they are listed and whether they are a credit or a debit. a) A U.S. citizen spends $500 for a hotel room in Paris. b) A Chinese company buys a solar power plant in the United States for one billion dollars. c) A French couple after running the New York City marathon pay $20 for a taxi ride back to their hotel. d) A U.S. investment bank earns $15,000 in interest on German bonds. e) The U.S. government sends $1,000,000 in aid to Egypt.
a) Debit current account (import of services) b) Credit capital account (increase in foreign assets in the U.S.) c) Credit current account (export of services) d) Credit current account (foreign interest income) e) Debit current account (transfer payment)
What unemployment rate should the Fed aim for?
as much stimulus as possible until the economy gets to the vertical part of the AS curve
how do firms smooth output relative to sales?
because holding inventories and changing production is costly, the firm is likely to smooth its production path relative to its sales path
what mechanisms would the Fed use to raise the interest rate?
change the rrr normally, but doesnt work anymore: banks have super larger reserves after GFC, so the Fed will increase the interest rate it pays for bank reserves (gov bonds the banks hold, etc). The supply of the bonds will go up, so the price of bonds will go down, so the market interest rate will increase.
What are three possible reasons that the labor market may not clear in the short run?
efficiency wage theory, imperfect information, minimum wage laws, sticky wages
Why is randomization in an experiment important?
if the subjects aren't randomly selected, there may be a selection bias. For instance, analyzing the effect of class size on test scores: just plotting class size vs test score is not random and it would be misleading, because large classes are most common for poor stupid students in underfunded inner city public schools, while small class sizes are characteristic of wealthy, smart students in a rich private school.
Why might depreciation lower output?
in the short run, balance of trade may decrease because of the J Curve 2. PIM increases, inflation increases, real wage decreases, real wealth decreases
Modigliani's Life Cycle Hypothesis
income varies systematically over human life cycle
3 things that developing countries need
infrastructure, low corruption, normal inflation
Why is it not sustainable in the long term for a country to not allow its currency to depreciate?
it will run out of the pegged currency?
How would an increase in discouraged workers affect the unemployment rate?
it would decrease the unemployment rate, because only people who are actively looking for a job are counted as unemployed
explain the theory behind the equation determining imports IM
m, the marginal propensity to import, is multiplied by output Y, to calculate how changes in output affect the import level. When Y rises, people have more money to spend on imports. the percent of income that is spent on imports is represented by m. P/PM factors in the relative cost of domestic goods vs imported goods. P is in the numerator, because the higher the price of domestic goods is, the more imports are purchased. PM is in the denominator, because the lower the prices of imported goods, the more attractive they are, so the more they are bought.
What is the argument for a vertical AS curve
most economists agree that the AS curve is vertical in the long run, but only some agree that the AS curve is vertical in the short run. A vertical AS curve means that wages adjust proportionally as prices adjust. Furthermore, there is likely to be an output level beyond which the economy no longer has an excess capacity to produce so that any increase in aggregate demand will be met with price increase (and proportional wage increase) rather than with output increase.
how would the Fed raise interest rates before 2008?
open market operations (buying and selling of government securities), rrr,
Give an example of a random experiment
otherwise identical classes are assigned an intervention, others serve as a control (e.g. a textbook, hybrid classroom, etc.) and then the students and teachers are not allowed to switch out for the duration of the study
vicious cycle of poverty hypothesis
poor nations are unable to save or invest enough to accumulate capital to grow
what does New Keynesian economics add to Real Business Cycle Theory?
price stickiness
What variables should be added to the investment equation to make it more realistic?**
r, W, Y^e, k^^-1, -k'^^-1
explain the theory behind the equation determining the exchange rate, e.
r/r* means that when the domestic interest rate rises vis a vis a foreign nation, the domestic currency appreciates. This is because a higher interest rate makes domestic securities more lucrative, which makes foreigners want to invest in domestic securities, which increases demand for domestic currency, which increases the value of domestic currency. vice versa for r* is in the denominator. p*/p means that when the domestic price level decreases vis a vis a foreign country, the domestic currency will appreciate. This is because when domestic goods are cheaper, demand for them increases both domestically and abroad. Consequently, more people want the domestic currency to be able to purchase these more appealing domestic goods, which increases the value of the domestic currency.
What is a discouraged worker
someone who gives up looking for a job without finding one
Accounting for what makes A dot nearly 0?
superior, new tech
why are declining US education levels worrisome?
that means less human capital, so less growth
Assuming fixed exchange rates, what happens when g* increases?
the AD* curve moves to the right, Y* increases, P* increases, so the fed rule kicks in so r* increases. Due to the price feedback, r will increase as well, because EX* is more expensive due to the rising price level, IM must be getting more expensive as well, so P increases. As a result, the fed tries to fight inflation by raising r. Because both r and r* have increased, I and I* decrease, because a rising interest rate crowds out investment. Investment decreases with a higher interest rate, because it is more expensive to borrow the money for large investments that firms usually dont have the money on hand for.
Why does the AS curve curve upward?
the AS curve is fairly flat at first because of things like contracts causing sticky wages, so wages don't rise as quickly as the price level rises, so output may increases more than the price level when the economy isn't at full strength like this. In the long run wages will adjust.
quantitative easing
the Fed buys up securities to decrease the long term interest rate - the money supply is unchanged, according to Prof. Fair - buying up mortgage based securities increases the price of mbs, so interest rate decreases
what is the theory behind the fed rule?
the Fed rule leans against the wind: when output or the price level is high, the fed will raise the interest rate to combat this; in addition, the fed rule considers miscellaneous factors such as consumer confidence
how does a stock market boom affect the government deficit?
the deficit will decrease income increases, so taxeable income increases, so tax revenue increases, so government income increases, so the government deficit decreases
what explains a firm's demand for investment (capital)?
the firm's expectation for future output, cost of capital (usually affected by r), amount of excess capital on hand
What explains a firm's demand for labor? cite at least 3 variables
the firm's expectation for future output, wage rates, amount of excess labor
How is the size of the government spending multiplier of a country affected by its marginal propensity to import
the larger its marginal propensity to import, the smaller the government multiplier, because a high percentage of g is spent on imported goods. Imported goods don't directly increase US GDP because US GDP only counts domestically produced goods and services.
the AS Curve
the total supply of goods and services in the economy. it shows the relationship between the aggregate quantity of output supplied by all firms in an economy and the overall price level. the purpose is to show how aggregate output and the price level change, corresponding to aggregate demand. "price/output response curve" correlation, not causation.
What does it mean to say that human capital is increasing
the workforce is becoming increasingly educated and more highly skilled, therefore, more productive
If a country had a high inflation rate relative to other countries for several years, but would not allow its currency to depreciate, what would happen?
this inflation will first cause domestic goods to increase in price. the central bank will raise the interest rates, planned investment will be crowded out, and output will fall domestically. In addition, this inflation makes domestic exports less attractive to other nations. Domestic goods have increased in price, but because the exchange rate hasn't changed, it will be more expensive for international consumers to import these domestic goods. They will shift towards their own domestic goods. Furthermore, the rising price of imports is a cost shock that moves the AS curve to the left, possibly triggering stagflation.
why does an increase in TR of 1.0 increase Y by less than an increase in g of 1.0 would? how does a changing value of b affect the difference?
transfer payments (TR) do not increase Y by as much as g would because when people get money (e.g. transfer payments), they save some of it. government spending (g), on the other hand, is all spent immediately on goods and services. changing the value of b changes the government spending multiplier: the higher b is, the higher the marginal propensity to consume. In other words, the higher b is, the smaller the difference is between TR and g in terms of increasing Y.
what are some difficulties with predicting and assessing the efficacy of the Laffer curve
using real world data, it is difficult to separate the income effect from the substitution effect
in the real business cycle model, how do fluctuations in productivity lead to fluctuations in output?
when production technology shocks change the marginal productivity of labor, people will work more if they are getting paid more (positive shock and higher productivity) and vice versa for a negative cost shock
If France lowers its work week from 35 hours to 32 hours and then keeps it at 32 hours, what effect will this have on its long-run growth rate of output?
workers could be more productive, more workers could be hired; rational expectations model could have been expecting this all along
how is the export multiplier changed under a balanced budget amendment?
x increases, Y increases, T increases, g increases, Y increases; the opposite if x decreases; the export multiplier is larger when there is a balanced budget amendmen