ECON FINAL EXAM STUDY GUIDE
unemployment rate
# of unemployed/labor force x100
If the reserve requirement is 10%, a withdrawal of $500 leads to a potential decrease in the money supply of:
$5,000.
Sumit deposits $1,500 cash into his checking account. The reserve requirement is 25%. How much money can the banking system create?
$6,000
income per capita =
(GDP/population)=(GDP/employment)x(employment/population)
inelastic demand
(remember bc D curve stands up like an "I") percentage change in quantity demanded is less than the percentage change in price-- the absolute value of the price elasticity is less than 1 inelastic goods are not responsive to changes in price
perfect elastic demand
(remember bc the graph looks like an "E" for elastic)
open market operations explanation
- Fed buys and sells government bonds on the open market - Fed buys bonds (basically creates money out of nothing)-> supply of reserves increases-> FFR decreases - Fed sells bonds-> supply of reserves decreases-> FFR increases
how does the Fed's buying and selling of bonds affect the economy?
- enables banks to make more loans - other interest rates in the economy tend to follow the FFR
ways to increase productivity
- increasing access to natural resources - increasing quality of labor (human capital) -increasing capital-to-labor ratio -promoting innovation and technology
monopolistic competition
- many buyers and sellers - differentiated products - little/no barriers to market entry/exit -no long run economic profit -some control over price (limited market power)
perfect competition characteristics
- many buyers and sellers - homogenous products - no barriers to market entry or exit - no long-run economic profit - no control over price (no market power)
oligopoly
-fewer firms (auto industry) -mutually interdependent decisions -substancial barriers to market entry -potential for long run economic profit -shared market power and considerable control over price
monopoly
-one firm -no close product substitutes -nearly insuperable barriers to entry -potential for long run economic profit -substancial market power and control over price
sources of market power
-significant control over factors of production (barriers to entry) - economies of scale - gov't franchises, patents, and copyrights
MPC+MPS=
1
The slope of the saving schedule is:
1 minus the marginal propensity to consume
steps to profit maximization in general
1. find where MC=MR 2. At the point where MC=MR, find the corresponding point on the horizontal axis, this is the profit-maximizing output 3. At the profit maximizing output, draw a line straight up to the demand curve and then to the vertical axis. This is the profit maximizing price 4. Again using the profit-maximing output, draw a line straight up to the average total cost curve, and then to the vertical axis. This is the ATC per unit 5. Find the profit, which is the rectangle formed between the profit maximizing price and average total cost on the vertical axis, and the profit maximizing output on the horizontal axis (so basically the area between ATC and demand curve is the profit)
how to find profit in perfectly competitive market
1. find where MC=MR 2. drop line from point down to ATC curve 3. Make box with vertical axis-- this is profit (P-ATC)*Q=TP or TR-TQ=TP
Fed's dual mandate
1. full employment 2. low and stable inflation
Fed's two major roles:
1. maintain the payments system in economy and financial stability 2. control the money supply and influence interest rates
three basic economics questions that each society must answer
1. what goods and services are to be produced? 2. how are these goods and services to be produced? 3. who will receive these goods and services?
multiplier equation
1/(1-MPC) or 1/MPS
number of years to double value=
70/growth rate
M2
A broader definition of money that includes "near monies" that are not as liquid as cash, including deposits in savings accounts, money market accounts, and money market mutual fund accounts. money that cannot be drawn on instantaneously but nonetheless accessible
Laffer curve
A curve that shows a hypothetical relationship between income tax rates and tax revenues. At point c, tax revenues are maximized. If tax rates continue to rise, tax revenues will decrease because higher tax rates discourage people from working and firms from producing. A government collects the same tax revenues at points a or b. The tax rates that correspond to points b and c are often debated by economists.
money multiplier
A formula that measures the potential or maximum amount the money supply can increase (or decrease) when a dollar of new deposits enters (exits) the system and is defined as 1 divided by the reserve requirement.
medium of exchange
A function of money in which goods and services are sold for money, then the money is used to purchase other goods and services.
money illusion
A misperception of wealth caused by a focus on increases in nominal income but not increases in prices.
leakages
A reduction in the amount of money that is used for lending that reduces the money multiplier. It is caused by banks choosing to hold excess reserves and from individuals, businesses, and foreigners choosing to hold more cash.
externalities
A side effect of an action that affects a third party other than the buyer or seller.
surplus
A situation in which quantity supplied is greater than quantity demanded
solvency crisis
A situation when a bank's liabilities exceed its assets.
regressive tax
A tax for which the percentage of income paid in taxes decreases as income increases
Expansionary monetary policy shifts the _____ curve to the _____.
AD; right
The 45-degree line in the Keynesian model represents:
AE = Y.
aggregate expenditure equation
AE=C+I
average fixed cost curve
AFC curve always decreases as production increases This is because, in the short run, total fixed costs do not change so that increasing production spreads the fixed costs over more units of output (the spreading effect).
Average Propensity to Consume (APC)
APC=C/Y consumption spending/income
Average Propensity to Save (APS)
APS=S/Y
functional finance
An approach that focuses on fostering economic growth and stable prices, while keeping the economy as close as possible to full employment.
money
Anything that is accepted in exchange for goods and services or for the payment of debt.
cyclically balanced budget
Balancing the budget over the course of the business cycle by restricting spending or raising taxes when the economy is booming and using these surpluses to offset the deficits that occur during recessions.
economies of scope
By producing a number of products that are interdependent, firms are able to produce and market these goods at lower costs.
components of GDP
C+I+G+(X-M)
paradox of thrift
Consumer uncertainty causes people to save more; consumption falls; equilibrium income and production falls; savings decreases because income is lower.
fractional reserve banking system
Describes a banking system in which a portion of bank deposits are held as vault cash or in an account with the regional Federal Reserve Bank, while the rest of the deposits are loaned out to generate the money creation process.
average total cost
Equal to total cost divided by output (TC/Q). Average total cost is also equal to AFC + AVC.
average variable cost
Equal to total variable cost divided by output (VC/Q).
Suppose policymakers wish to use fiscal policy to fight inflation. Which statement, then, is MOST accurate?
Essentially, the way to lower the inflation rate is to decrease aggregate demand, causing a rise in unemployment.
annually balanced budget
Expenditures and taxes would have to be equal each year.
contractionary monetary policy
Fed actions designed to decrease the money supply and raise interest rates to shrink income and employment, usually to fight inflation.
easy money, quantitative easing, or accommodative monetary policy
Fed actions designed to increase excess reserves and the money supply to stimulate the economy (increase income and employment).
expansionary monetary policy
Fed actions designed to increase the money supply and lower interest rates to stimulate the economy (expand income and employment).
The main policymaking arm of the Fed is the:
Federal Open Market Committee
oligopoly
Fewer firms (such as the auto industry) Mutually interdependent decisions Substantial barriers to market entry Potential for long-run economic profit Shared market power and considerable control over price
GDP-PPP
GDP adjusted for cost of living relative to a base country
real GDP
GDP adjusted for inflation-- uses a base year to account for inflation
GDP components
GDP= C(consumption)+I(investments)+G(gov't spending)+(x-m)net exports
public good
Goods that are neither excludable nor rival in consumption. Consumption by one person cannot diminish the benefit to others of consuming the good.
GDP per capita
Gross domestic product divided by the number of people in the population. Used to find the country's standard of living
laissez-faire
Hands off. No government intervention.
supply
How much of a good or service a producer is willing and able to produce at different prices.
liquidity
How quickly, easily, and reliably an asset can be converted into cash.
multiplier
K=1/(1-MPC) or K=1/MPS
monetary rule
Keeps the growth of money stocks such as M1 or M2 on a steady path, following the equation of exchange (or quantity theory), to set a long-run path for the economy that keeps inflation in check.
antitrust laws
Laws designed to promote competition and fairness to prevent monopolies
equation of exchange
M × V = P × Q where V and Q are fixed, thus: change in M=change in P where M is the supply of money, V is the velocity of money (the average number of times per year a dollar is spent on goods and services, or the number of times it turns over in a year), P is the price level, and Q is the economy's real output level.
what is the relationship between marginal revenue and price for a monopoly?
MR<P, because the demand curve is downward sloping Because the monopolist's demand curve is identical to the market demand curve, the monopolist can sell an additional unit of output only by lowering the product's price. Assuming no price discrimination (charging different customers different prices for the same good), this lower price is charged for all units of the commodity sold. As a consequence, the firm's marginal revenue curve lies below its demand curve. Marginal revenue is less than price.
long-run equilibrium for the perfectly competitive firm
Market price in the long run is PLR, corresponding to the minimum point on the SRATC and LRATC curves. At point e, P = MR = MC = SRATCmin = LRATCmin. This is why economists use perfectly competitive markets as the benchmark when comparing the performance of other market structures. With competition, consumers get just what they want because price reflects their desires, and they get these products at the lowest possible price (LRATCmin). Further, as panel A illustrates, the sum of consumer and producer surplus is maximized. Any reduction in output reduces the sum of consumer and producer surplus.
MONETARIST THEORY ON MONEY SUPPLY
Monetarists argue that a change in output will last only for the short run; in the long run, the economy will move back to full employment. The economy begins in equilibrium at point e. An increase in the money supply of 10% shifts the aggregate demand curve from AD0 to AD1, resulting in higher short-run output, $16 trillion, and a higher price level at point b. Over time, the economy will move back to full employment output ($15 trillion), increasing the price level in the long run to 110 (a 10% increase) at point c. The long-run aggregate supply curve is vertical at the full employment output of $15 trillion.
DEMAND SHOCKS, SUPPLY SHOCKS, AND MONETARY POLICY
Monetary policy can be effective in counteracting a demand shock. In panel A, the economy begins in full employment equilibrium at point e and then a demand shock reduces aggregate demand to AD1, resulting in a new equilibrium (point a). Expansionary monetary policy will shift aggregate demand back to AD0, restoring full employment output ($15 trillion) and prices (100). Monetary policy is less effective in counteracting a supply shock. In panel B, a negative supply shock shifts SRAS0 to SRAS1. The new equilibrium (point a) is at a higher price level, 105, and lower output, $14 trillion, a doubly negative result. The Fed could use expansionary monetary policy to shift AD0 to AD1; this would restore the economy to full employment output (point b), but at an even higher price level (110). Alternatively, the Fed could focus on price level stability, using contractionary monetary policy to shift aggregate demand to AD2, but this would further deepen the recession as output falls to $13 trillion (point c).
fiat money
Money without intrinsic value but nonetheless accepted as money because the government has decreed it to be money.
monopoly
One firm No close substitutes for product Nearly insuperable barriers to entry Potential for long-run economic profit Substantial market power and control over price
What occurs during a negative demand shock?
Output and price level decrease.
total product curve, marginal product, and average product
Panel A shows how increasing labor increases productivity, up to a point. Panel B shows marginal and average product. Marginal product reaches its maximum as the third worker is hired, after which marginal product starts decreasing. Total product keeps increasing, however, until you reach 6 employees. At that point, marginal product becomes negative, meaning that each additional employee actually reduces production.
contractionary fiscal policy
Policies that decrease aggregate demand to contract output in an economy. These include reducing government spending, reducing transfer payments, and/or raising taxes.
supply-side fiscal policies
Policies that focus on shifting the long-run aggregate supply curve to the right, expanding the economy without increasing inflationary pressures. Unlike policies to increase aggregate demand, supply-side policies take longer to impact the economy.
expansionary fiscal policy
Policies that increase aggregate demand to expand output in an economy. These include increasing government spending, increasing transfer payments, and/or decreasing taxes.
discretionary fiscal policy
Policies that involve adjusting government spending and tax policies with the express short-run goal of moving the economy toward full employment, expanding economic growth, or controlling inflation.
teaser rates
Promotional low interest rates offered by lenders for a short period of time to attract new customers and to encourage spending.
externally held debt
Public debt held by foreigners, including foreign industries, banks, and governments.
internally held debt
Public debt owned by domestic banks, corporations, mutual funds, pension plans, and individuals.
excess reserves
Reserves held by banks above the legally required amount.
long-run adjustments with short-run economic profits for perfectly competitive firms
Short-run economic profits lead other firms to enter the industry, thus raising industry output to QL in panel A, while forcing prices down to PL. The output for individual firms declines as the industry moves to long-run equilibrium at point b. In the long run, firms in perfectly competitive markets can earn only normal profits, as shown by point b in panel B.
five step process to determine maximum profit
Step 1: Find the point at which marginal revenue (MR) equals marginal cost (MC). Remember that in a perfectly competitive market, MR equals price. Step 2: At the point at which MR = MC, find the corresponding point on the horizontal axis; this is the profit-maximizing output. Step 3: At the profit-maximizing output, draw a line straight up to the demand curve (which is equal to MR in a perfectly competitive market) and then to the vertical axis. This is the profit-maximizing price. Step 4: Again using the profit-maximizing output, draw a line straight up to the average total cost curve, and then to the vertical axis. This is the average total cost per unit. Step 5: Find the profit, which is the rectangle formed between the profit-maximizing price and average total cost on the vertical axis, and the profit-maximizing output on the horizontal axis.
asset that pays a rate roughly equal to the rise in prices (inflation)
TIPS (treasury inflation-protected security) bond
Which statement concerning the structure of the Federal Reserve System is correct?
The Chair and Vice Chair of the Board of Governors are appointed by the president and confirmed by the Senate for terms of 4 years.
surplus
The amount by which annual tax revenues exceed government expenditures.
average total cost, average variable cost, and marginal cost
The bowl shape of the AVC and ATC curves demonstrates the law of diminishing returns: Beyond a certain level of output, average costs increase. Marginal costs represent the added cost of producing one more unit of output. Note that the marginal cost curve passes through the minimum points on both the AVC and ATC curves.
open market operations
The buying and selling of U.S. government securities, such as Treasury bills and bonds, to adjust reserves in the banking system.
marginal cost
The change in total costs arising from the production of additional units of output (ΔTC/ΔQ). Because fixed costs do not change with output, marginal costs are the change in variable costs associated with additional production (ΔVC/ΔQ). MC = ΔTC/ΔQ = ΔFC/ΔQ + ΔVC/ΔQ
barter
The direct exchange of goods and services for other goods and services.
public choice theory
The economic analysis of public and political decision making, looking at issues such as voting, the impact of election incentives on politicians, the influence of special interest groups, and rent-seeking behaviors
THE MULTIPLIER AND GOVERNMENT SPENDING
The economy is initially in equilibrium at point e. As new government spending works its way through the economy round-by-round, both income and output are multiplied, but price increases absorb some of the increase in AD. Once the economy reaches full employment (point a), price increases absorb all of the increase in AD.
compounding effect
The effect of interest added to existing debt or savings leading to substantial growth in debt or savings over the long run.
store of value
The function that enables people to save the money they earn today and use it to buy the goods and services they want tomorrow.
government budget constraint
The government budget is limited by the fact that G − T = ΔM + ΔB + ΔA where G = government spending T = tax revenues; thus, (G − T) is the federal budget deficit ΔM = the change in the money supply (selling bonds to the Federal Reserve) ΔB = the change in bonds held by public entities, domestic and foreign ΔA = the sales of government assets
federal funds rate
The interest rate financial institutions charge each other for overnight loans used as reserves.
discount rate
The interest rate the Federal Reserve charges commercial banks and other depository institutions to borrow reserves from a regional Federal Reserve Bank.
M1
The narrowest definition of money that measures highly liquid instruments including currency (banknotes and coins), demand deposits (checks), and other accounts that have check-writing or debit capabilities. most liquid part of the money supply
tradeoff between risk and return
The pattern of higher risk assets offering higher average annual returns on investment than lower risk assets.
reserve ratio
The percentage of a bank's total deposits that are held in reserves, either as cash in the vault or as deposits at the regional Federal Reserve Bank.
public debt
The portion of the national debt that is held by the public, including individuals, companies, pension funds, along with foreign entities and foreign governments. This debt is also referred to as net debt or federal debt held by the public.
reserve requirement
The required ratio of funds that commercial banks and other depository institutions must hold in reserve against deposits.
recognition lag
The time it takes for policymakers to confirm that the economy is in a recession or a recovery. Short-term variations in key economic indicators are typical and sometimes represent nothing more than randomness in the data.
information lag
The time policymakers must wait for economic data to be collected, processed, and reported. Most macroeconomic data are not available until at least one quarter (three months) after the fact.
implementation lag
The time required to turn fiscal policy into law and eventually have an impact on the economy.
national debt
The total debt issued by the U.S. Treasury, which represents the total accumulation of past deficits less surpluses. A portion of this debt is held by other government agencies, and the rest is held by the public. It is also referred to as the gross federal debt.
FISCAL POLICY AND AGGREGATE SUPPLY
The ultimate goal of fiscal policy directed at aggregate supply is to shift the long-run aggregate supply curve from LRAS0 to LRAS1. This moves the economy's full employment equilibrium from point a to point b, expanding output from Q0 to Q1 while keeping inflation in check. With these fiscal policies, inflationary pressures are reduced as output expands, but these policies take a longer time to have an impact.
long-run average total cost
This figure shows the average total cost curve for three plants of different sizes. The larger plants have relatively high average total costs at lower levels of output, but much lower average total costs at higher output levels. Firms are free to adjust plant size in the long run; therefore, they can switch from one plant type to the next to MINIMIZE their costs at each production level. The green envelope curve represents the firm's lowest cost to produce any given output in the long run and represents the LRATC curve.
THE MARKET FOR LOANABLE FUNDS
This market represents supply and demand for loanable funds. Savers spend less than they earn and supply the excess funds to the market. Borrowers (primarily businesses) have potential profit-making investment opportunities, and this leads to their demand for funds. Equilibrium is at point e. supply curve represents the savers while the demand curve represents the borrowers
The rule of 70
To estimate the number of years for a variable to double, take the number 70 and divide it by the growth rate of the variable.
substitute goods
Two goods are consumer substitutes if they provide essentially the same utility to the consumer-- when the price of one good rises, the demand for the other good increases
complementary goods
Two goods that provide more utility when consumed together than when consumed separately-- when the price of one good rises, the demand for the other one falls PB&J!!!!
Which of the following items is NOT public debt? Treasury notes Treasury bonds U.S. dollars U.S. savings bond
US dollars
expansionary fiscal policy at full employment
When an economy is already at full employment, expansionary policies lead to no long-run improvement in real GDP. Beginning at full employment (point e), increasing aggregate demand moves the economy to output level Q1 above full employment (point a). This higher output is only temporary, however, as workers and suppliers adjust their expectations to the higher price level (P1), thus shifting short-run aggregate supply left toward SRAS2. But this just pushes prices up further, until finally workers adjust their inflationary expectations, and the economy settles into a new long-run equilibrium at point b, where the economy is again at full employment, but at a higher price level (P2).
liquidity trap
When interest rates are so low, people hold on to money rather than invest in bonds due to their expectations of a declining economy or an unforeseen event such as war.
expansionary fiscal policy below full employment
When the economy is below full employment, expansionary policies move it to full employment. Here, the economy begins at equilibrium at point e, below full employment. Expansionary fiscal policy increases aggregate demand from AD0 to AD1, raising equilibrium output to Qf and the price level to P1 (point f).
a perfectly competitive form minimizing losses
When the market price falls below the average total cost of production curve, but remains above average variable cost. In this situation, it is best to keep producing because fixed costs still have to be payed, and without production, losses would amount.
sole proprietorship
a business owned and managed by a single individual who is subject to unlimited liability
deflation
a decline in overall prices throughout the economy.
Simultaneous recession and deflation can be explained by:
a decrease in aggregate demand.
price ceiling
a legal maximum on the price at which a good can be sold. When price ceiling is set below equilibrium, a shortage occurs
price floor
a legal minimum on the price at which a good can be sold. when a price floor is set above equilibrium, a surplus results
perfect competition
a market structure in which a large number of firms all produce the same product no barriers to entry or exit no long-run economic profit no control over price (no market power)
price elasticity of demand (Ed)
a measure of how responsive quantity demanded is to a change in price Ed= (% change in Qd/ % change in P)
income elasticity of demand
a measure of how responsive quantity demanded is to changes in consumer income
cross elasticity of demand
a measure of how responsive the quantity demanded of one good is to changes in the price of another good
GDP deflator
a measure of price inflation/deflation with respect to a specific base year . Unlike the CPI, the GDP deflator is not based on a fixed basket of goods and services; the "basket" for the GDP deflator is allowed to change from year to year with people's consumption and investment patterns.
fiscal sustainability
a measure of the present value of all projected future revenues compared to the present value of projected future spending.
increasing marginal returns
a new worker hired adds more to total output than the previous worker hired, so that both average and marginal products are rising
disinflation
a reduction in the rate of inflation (inflation still present, but is decreasing)
classical economics
a school of thought based on the idea that free markets regulate themselves, and that rising debt is unsustainable and creates and undue burden on future generations that can prevent them from achieving their economic goals
What would cause the price level to decrease and employment to increase?
a shift to the right of the SRAS curve
productive efficiency
a situation in which a good or service is produced at their lowest resource (opportunity) cost
asymmetric information
a situation in which one party to an economic transaction has less information than the other party
shortage
a situation in which quantity demanded is greater than quantity supplied
market failure
a situation in which the market does not distribute resources efficiently and does not provide a socially optimal level of output (usually too high or low of a price)
According to Malthus, a fixed quantity of land and a growing human population will eventually produce:
a stationary state in which growth will cease.
flat tax
a tax system in which all people pay the same percentage of their income
lump-sum tax
a tax that is the same amount for every person-- a type of regressive tax
progressive tax
a tax that rises in percentage of income as income increases
keynesian economics
active role in government is needed to ensure that economic activity is promoted in areas where markets cannot do it alone. Theory that the government must spend money to stimulate the economy during recessions.
_____ is the output of goods and services demanded at different price levels.
aggregate demand
The solution to simultaneous deflation and unemployment is to shift the:
aggregate demand curve to the right.
profit-maximizing rule
all firms maximizing profit by producing where marginal return (MR) = marginal cost(MC). No other level of output produces higher profits.
At equilibrium
all spending injections into the economy equal all withdrawals of spending. I + G + X = S + T + M
diminishing marginal returns
an additional worker adds to total output, but at a diminishing rate
consumer price index (CPI)
an index of the average prices paid by urban consumers for a typical market basket of consumer goods and services. aka cost of living index CPI=(cost now/base cost)x100
producer price index (PPI)
an index of the average prices received by domestic producers for their output
willingness-to-pay (WTP)
an individual's valuation of a good or service, equal to the most an individual is willing and able to pay
natural monopoly
an industry in which one firm can achieve economies of scale over the entire range of market supply
increasing cost industry
an industry that faces higher per unit production costs as industry output expands in the long run
All of the following are functions of money EXCEPT: as a medium of exchange. as a unit of account. as a standard value. as a store of value.
as a standard value
long run industry supply curves
as industry expands, costs can increase, remain the same, or decrease
assets and liabilities for banks
assets- cash reserves and loans made liabilities-- deposits by customers
why is the LRAS curve vertical?
b/c prices and wages adjust, so output is not affected by the price level in the long run.
why is the SRAS curve upward sloping?
b/c prices and wages are sticky in the short run, so firms respond by increasing output when prices rise
why is the PPF graph concave?
because opportunity costs rise as more factor are used to produce increasing quantities of one product
corporation
body authorized by law to act as a single person and to have rights and duties. In addition it can issue stock to raise capital
GDP deflator
broadest measure of inflation, it is an index of all goods and services in the economy, including consumer goods, investment goods, gov't goods and services, and exports
Developing countries can achieve higher productivity per unit of capital because they can use technologies developed by other countries. This is known as the:
catch-up effect.
marginal propensity to consume (MPC)
change in consumption / change in income
marginal propensity to save (MPS)
change in savings/ change in income
third-degree price discrimination
charging different groups of people different prices based on varying elasticities of demand. ex. airline, bus, and movie theatre tickets
perfect (first degree) price discrimination
charging each customer the maximum price each is willing to pay, thereby expropriating all consumer surplus-- online auction
The idea that a change in the money supply would affect prices but not real GDP is associated with the:
classical monetary transmission mechanism.
rival and nonexclusive good ex
common property resource-- ocean fishery or highway
the income approach to calculating GDP
compensation of employees (wages, salaries and benefits + proprietors' income + corporate profits + net interest + miscellaneous adjustments
total surplus
consumer surplus + producer surplus, a measure of the overall net benefit gained from a market transaction
The largest component of GDP is:
consumption expenditure.
the determinants of aggregate demand include the components of aggregate spending:
consumption spending investment spending government spending net exports
sunk costs
costs that are made in the past and cannot be recovered ex. reason why you shouldn't keep snowboarding with a broken wrist, even when you payed $100 for a full day pass
fixed costs
costs that remain constant as output changes, often called over-head
variable costs
costs that vary with the quantity of output produced, including costs such as labor and material costs
withdrawals
decrease spending in an economy, and include savings (S), taxes (T), and imports (M)
causes of inflation
demand factors: consumer confidence, income, or wealth supply shocks: when input prices increase, this not only raises the cost of living for individuals, but also raises the cost for businesses to produce and transport goods once produced government policy: when too much money (printed) chases a fixed quantity of goods and services, prices are bid up, leading to inflation
demand and supply shocks
demand shocks affect the AD curve: -caused by: consumer confidence, business sentiment, or export demand - monetary policy is more effective because targeting one goal automatically targets the other supply shocks affect the SRAS curve: - caused by changing input prices or technological innovation - monetary policy is less effective because targeting one goal makes the other target worse
An increase in the interest rate causes the aggregate _____ curve to shift _____.
demand; left
_____ is a reduction in the rate of inflation.
disinflation
he 45-degree line in the Keynesian model represents a set of points where _____ equals _____.
disposable income; consumption
how is CPI calculated
dividing market basket's cost in current period by its cost in the base period times 100
unemployed
does not have job, but is available for work and has been actively searching for the previous four weeks
problems with CPI
doesn't measure public goods doesn't take into account things like environment, homeland security, life expectancy, crime rates tends to overstate inflation due to product substitution, quality improvements, and the introduction of new products only accounts for out-of-pocket spending on health care, and not the overall health care spending
main factors of economic growth
economic freedom strong and fair legal system stable monetary system
what is the most important factor influencing a country's standard of living?
economic growth
factors that shift the supply of loanable funds
economic outlook incentives to save income or asset price government deficits
gov't is a guarantor of economic growth
enforcement of contracts, protection of property rights, stable financial system, and promoting free and competitive markets
constant cost industry
entry (or exit) does not shift the cost curves of firms in the industry
decreasing cost industry
entry of new firms shifts the cost curves for all firms downward
normal profits
equal to zero economic profits, where P=ATC
two basic determinants of economic growth
expanding resources and improving technologies
determinants of investment demand
expectations, technological change, operating costs, capital goods on hand
tax burden with elastic demand and inelastic supply
falls mostly on producer
Assume initially that market interest rates are 7% and the bondholder is receiving a $70 coupon payment per year on a bond with a face value of $1,000. If market interest rates rise to 8%, the bond price:
falls to $875.
tight money or restrictive monetary policy
fed actions designed to decrease excess reserves and the money supply to shrink income and employment, usually to fight inflation.
The U.S. gross domestic product is equal to the total market value of all:
final goods and services produced by resources in the United States.
financial intermediaries
firms that help to channel funds from savers to borrowers-- includes banks, mutual funds, insurance companies
The long-run aggregate supply curve uses the classical assumptions that all variables are _____ in the long run and that long-run equilibrium occurs at _____.
flexible; full employment
Core inflation is found by removing _____ from the consumer price index.
food and energy
Fed's objectives
full employment, stable prices, and moderate long-term interest rates
substitutes
goods consumers substitute for one another depending on their relative prices, such as coffee and tea. Substitutes have a positive cross elasticity of demand.
luxury goods
goods that have income elasticities greater than 1. When consumer income grows, demand for luxury goods rises more than the rise in income.
inferior goods
goods that have income elasticities that are negative. when consumer income grows, demand for inferior goods falls.
normal goods
goods that have positive income elasticities less than one. when consumer's income rises, demand for normal goods rises, but less than the rise in income
Open market operations involve the purchase and sale of:
government securities
for a given demand of some products, the higher the price elasticity of supply, the ______ the share of the total tax burden shifted to consumers
greater
for a given supply of some products, the lower the price elasticity of demand, the ______ the share of the total tax burden shifted to consumers
greater
decision lag
he time it takes Congress and the administration to decide on a policy once a problem is recognized.
coase theorem
if transaction costs are minimal, private bargaining will result in an efficient allocation of resources, thus socially optimal level of production will be reached
difference between short and long run (2 things)
in the short run, one factor of production is usually fixed, such as the firm's plant size, and firms cannot leave or enter the industry
effect of an excise tax on airline tickets
in this case, producers and consumers share the burden of the tax equally
In the Keynesian model, the principal determinant of saving is:
income
what is the main determinant of consumption and saving?
income
reasons why LRAS curve might shift:
increase in technology greater human capital trade innovation and R&D
When current real output exceeds potential real output, the Federal Reserve will _____ interest rates in an effort to fight _____
increase; inflation
A rising aggregate price level _____ an economy's interest rates and therefore _____ output demanded.
increases; reduces
Which of the following policies do supply-side economists believe is the best for increasing the standard of living?
increasing investment in capital that boosts worker productivity
ways to expand resources:
increasing labor and human capital (investment in human capital) and increasing the capital used throughout the economy (brought about by investment)
The largest source of federal government revenues is:
individual income taxes
An expansionary fiscal policy can result in:
inflation and a higher GDP
what are known as twin evils in modern macroeconomics
inflation and unemployment
The _____ lag is the time policymakers must wait for economic data to be collected, processed, and reported.
information
factors that shift SRAS curve?
input prices productivity taxes and regulations market power of firms inflationary expectations
bond prices and interest rates are ______ related
inversely
shifts in the demand for loanable funds
investment tax incentives technological advances regulations product demand business expectations
gross private domestic investment (GPDI)
investments in things such as structures (residential and non), equipment , and software, and changes in private inventories
injections
investments, gov't spending, and exports (all increase spending in an economy)
allocative efficiency
is a state of the economy in which production represents consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing.
According to public choice theorists, deficit spending:
is undertaken as a politically palatable way of funding programs.
reasons for market failure (4)
lack of competition, asymmetric information, the existence of external benefits/costs, the existence of public goods
factors of production
land (N), labor (L) including human capital, capital (K) which are manufactured goods used in production process, and entrepreneurship ability (A)
added government spending leads to a ___ increase in GDP when compared to the same reduction in taxes
larger
long-run adjustments with short-run economic losses for perfectly competitive firms
leads to the short-run economic losses shown in the shaded area in panel B, thus inducing some firms to exit the industry. Industry output contracts to QL in panel A, raising prices to PL and expanding output for the individual firms remaining in the industry, as the industry moves to long-run equilibrium at point b. Again, in the long run, firms in perfectly competitive markets will earn normal profits, as shown by point b in panel B.
a stronger dollar will shift the U.S. aggregate demand curve to the _____ and _____ output demanded.
left; decrease
national income and product accounts
lets economists judge our nation's economic performance , compare US income and output to that of other nations, and track the economy's condition over the course of a business cycle
economies of scale
long-run average total cost falls as the quantity of output increases
The focus of supply-side fiscal policies is on:
long-run economic growth
We are most likely to see a recession if interest rates on long-term bonds are:
lower than interest rates on short-term bonds.
Checking deposits generally have a _____ return on investment than do certificates of deposit because checking deposits are _____.
lower; more liquid
The short-run aggregate supply curve is positively sloped because:
many input prices are slow to change in the short run.
_____ is the change in consumption associated with a change in income.
marginal propensity to consume
equilibrium
market forces are in balance when the quantities demanded by consumers just equal the quantities supplied by producers
total factor productivity
measure of productivity including all things how quantity and quality of inputs could influence production
price elasticity of supply
measures the responsiveness of quantity supplied to changes in price of the product.
properties of money
medium of exchange, unit of account, store of value, liquidity
unit of account
money provides a yardstick for measuring and comparing the values of a wide variety of goods and services. It eliminates the problem of double coincidence of wants associated with barter.
If the pound sterling appreciates against the U.S. dollar, England buys _____ U.S. goods, causing the U.S. aggregate demand curve to shift to the _____.
more; right
In the equation of exchange, the term P × Q is the same as:
nominal GDP
multiplier effect
occurs when a dollar of spending generates more dollars of spending in the economy
market failure
occurs when a free market does not lead to a socially desirable outcome
misallocation of resources
occurs when a good or service is not consumed by the person why values it the most, and typically results when a price ceiling creates an artificial shortage in the market
short run growth
occurs when an economy makes use of existing or under-utilized resources, as seen as a movement from inside PPF towards PPF
change in demand
occurs when one or more of the determinants of demand changes, shown as a shift in the entire demand curve
change in supply
occurs when one or more of the determinants of supply change, shown as a shift in the entire supply curve
change in quantity supplied
occurs when the price of a product changes, shown as a movement along an existing supply curve
changes in quantity demanded
occurs when the price of the product changes, shown as a movement along an existing demand curve
comparative advantage
one country has a lower opportunity cost of producing a good than another country
The main tool of monetary policy is:
open market operations
average product
output per worker-- found by dividing total output by the number of workers employed to produce that output
examples of perfect competition firms
paper for copy machines, agricultural products, computer memory chips
rate of return regulation
permits product pricing that allows the firm to earn a normal return on capital invested in the firm
The four types of spending in GDP are
personal consumer spending, gross private domestic investment, government spending, and net exports
role of gov't in promoting economic growth
physical capital: building/maintenance of country's public capital human capital; providing subsidized public education, financial aid grants, and loans technology: funding research via grants and the establishment of major government research labs
discouraged workers
portion of marginally attached workers who have given up actively looking for work and, as a result, are not counted as unemployed
second-degree price discrimination
practice of charging different prices per unit for different quantities of the same good or service
unitary elastic supply
price elasticity of supply is equal to 1. The percentage change in quantity supplied is equal to the percentage change in price Es=1
elastic supply
price elasticity of supply is greater than 1. The percentage change in quantity supplied in greater than the percentage change in price Es>1 elastic supply curves always cross the price axis-- are more flat
inelastic supply
price elasticity of supply is less than 1. The percentage change in quantity supplied in less than the percentage change in price Es<1 inelastic supply curves always cross the quantity axis-- more vertical
total revenue
price per unit times quantity sold
total revenue
price x quantity
capital/market economies
private firms and individuals own most of the resources
long run
production period long enough to adjust all factors of production, including plant capacity
determinants of supply (6)
production technology costs of resources prices of related commodities expectations the # of sellers (producers) in the market taxes and subsidies
Which is a determinant of aggregate supply?
productivity
productive efficiency
products are produced and sold to customers at their lowest possible opportunity cost
monopolistic competition
products that are similar but not identical many buyers and sellers differentiated products little to no barriers to market entry or exit no long-run economic profit some control over price (limited market power) a market structure in which many companies sell
economic profit
profit in excess of normal profits. These are profits in excess of both explicit and implicit costs
x-inefficiency
protected from competitive pressures, monopolies do not have to act efficiently. ex. spending money on luxury corporate jets, lavish travel, and more nonessential perks.
nonrival and exclusive good ex
public good with exclusion, such as cable tv or satellite radio
rival and exclusive good ex
pure private good. airline seat.
nonexclusive and nonrival good ex
pure public good-- national defense or public broadcasting
High taxes and/or heavy regulation:
raise costs of production so that the aggregate supply curve shifts to the left.
GDP deflator equation
real = nominal x (base year index/current year index)
what two gaps occur when economy moves away from full employment equilibrium?
recessionary gap and inflationary gap
losses associated with monopolies
reduced output at higher prices, deadweight losses, rent-seeking behavior of monopolists, and x-inefficiency losses
Which of the following is an example of contractionary fiscal policy?
reducing military spending
When a financial institution provides a standardized financial product such as a mortgage, it is:
reducing transaction costs.
_____ government spending, _____ transfer payments, and _____ taxes are all examples of contractionary fiscal policy.
reducing, reducing, raising
incidence of taxation
refers to who bears the economic burden of the tax, which is determined by the price elasticities of demand and supply
marginal cost pricing rule
regulators would prefer for natural monopolists to price where MC=P, but this would result in losses in the long run, as ATC>MC
average cost pricing rule
requires a regulated monopolist to produce and sell output where price equals average total cost. This permits the regulated monopolist to earn a normal return on investments over long run, and therefore remain in business
long-run growth
requires an expansion of production capacity through an increase in resources and/or technology (WHOLE PPF curve shifts outward0
rent seeking
resources expended to protect a monopoly's position. ex. lobbying, extending patents, etc. it is behavior directed towards avoiding competition
automatic stabilizers
revenues and transfer payments automatically expand or contract in ways that reduce the intensity of business fluctuations without any overt action by Congress or other policymakers.
If oil prices decline, the short-run aggregate supply curve shifts _____ and output supplied will _____.
right; increase
Increased consumer confidence will shift the aggregate demand curve to the _____ and _____ output demanded.
right; increase
The crowding-out effect recognizes that if the government sells bonds to finance spending, it can cause interest rates to _____ investment.
rise, thereby reducing
Which list represents monetary policy actions that are consistent with one another?
sell government bonds, raise reserve requirements, raise the discount rate
long run adjustments with short run losses (perfectly competitive industry)
short run losses cause some firms to exit, raising the price and moving the demand curve up to the ATC curve so normal profits are made
Cost-push inflation is a situation in which the:
short-run aggregate supply curve shifts leftward.
aggregate supply curve
shows the real GDP firms will produce at varying price levels
The largest category of federal government spending in 2015 was:
social security
mandatory spending
spending authorized by permanent laws that does not go through the same appropriations process as discretionary spending. Mandatory spending includes Social Security, Medicare, and interest on the national debt.
GDP can be found either by adding up all of the _____ or all of the _____ in the economy.
spending; income
If a product becomes obsolete and the workers who produced that product will need additional training to find new jobs, then they are experiencing:
structural unemployment
long run adjustments with short run economic profits (perfectly competitive industry)
supply shifts from S2 to S1 as more firms enter, which drives prices from P2 to P1 In the long run, this causes firms in perfectly competitive markets to earn only normal profits
planned economies (socialist and communist)
systems in which most of the productive resources are owned by the state and most economic decisions are made by central governments
determinants of demand
tastes/preferences income prices of related goods # of buyers expectations about future prices, incomes and product availability
Which organization determines the beginning and end dates of a recession?
the National Bureau of Economic Research
Which of the following groups must agree in order to implement fiscal policy?
the Senate, House of Representatives, and executive branch
absolute advantage
the ability to produce more of a given product than another producer/country using a given amount of resources
price level
the absolute level of a price index, which can included Consumer Price index (CPI; retail prices), producer price index(PPI; wholesale prices), or the GDP deflator (avg pricing of all items in GDP)
If banks increase excess reserves to increase their ability to absorb a higher rate of defaults:
the actual multiplier will fall.
marginal revenue
the additional income from selling one more unit of a good; equal to price in a perfectly competitive firm MR = ΔTR/Δq
deficit
the amount by which annual government expenditures exceed tax revenues.
price discrimination
the business practice of selling the same good at different prices to different customers
marginal propensity to consume
the change in consumption associated with a given change in income (change in C/change in Y)
marginal propensity to save
the change in savings associated with a given change in income (change in C/change in Y)
marginal revenue
the change in total revenue from selling an additional unit of output MR= ΔTR/Δq marginal revenue is equal to price in perfectly competitive firms!!
consumption income graph
the consumption line starts above the origin on the vertical axis, because even w/ no income, one still consumes by borrowing as income increases, consumption rises, but not as fast as income
producer surplus
the difference between the current market price and the cost of production for the firm
consumer surplus
the difference between the willingness to pay for a good and the price that is paid to get it
accounting profit
the difference between total revenue and explicit costs. These are the profits that are taxed by the government
CONTRACTIONARY FISCAL POLICY TO REDUCE INFLATION
the economy is overheating at point e, with output above full employment. Contractionary policies reduce aggregate demand to AD1, bringing the economy back to full employment at price level P1. These policies prevent an inflationary spiral, but the fall in aggregate output leads to an increase in unemployment.
If a government always balances its budget:
the effect of an increase in government spending on aggregate expenditures is weakened.
personal consumption expenditures
the expenditures of households for durable and nondurable consumer goods and services in the United States
who makes decisions in the fed
the federal open market committee (FOMC)-- has 12 members
marginal product
the increase in output that arises from an additional unit of input (change in quantity over change in labor)
Firms decide how much to invest by comparing the rate of return on their projects with:
the interest rate.
short-run supply curve
the marginal cost curve above the minimum point on the average variable cost curve THIS WAS A TEST QUESTION LAST TIME
gross domestic product (GDP)
the market value of all final goods and services produced within a country in a given period of time
gross national product (GNP)
the market value of goods and services produced by labor and property supplied by U.S. residents
Monetary targeting is setting a steady growth rate in:
the money supply
Which of the following tends to make aggregate demand decrease by more than the amount that consumer spending decreases?
the multiplier effect
implicit costs
the opportunity costs of using resources that belong to the firm, including depreciation, depletion of business assets, and the opportunity cost of the firm's capital employed in business
A production function shows:
the output that is produced using different combinations of inputs combined with existing technology
discretionary spending
the part of the budget that works its way through the appropriations process of congress each year and includes national defense, transportation, science, environment, and income security
elastic demand
the percentage change in quantity demanded is greater than the percentage change in price. This results in the absolute value of the price elasticity of demand to be greater than 1 goods with elastic demands are very responsive to changes in price
average propensity to save (APS)
the percentage of income saved (S/Y)
average propensity to consume (APC)
the percentage of income that is consumed (C/Y)
diseconomies of scale
the property whereby long-run average total cost rises as the quantity of output increases. firms oftentimes become so big that management becomes bureaucratic and unable to control its operations efficiently
constant returns to scale
the property whereby long-run average total cost stays the same as the quantity of output changes ex the expansion of fast-food restaurant chains/movie theaters reflect this
As the real interest rate falls:
the quantity demanded of loanable funds rises.
what does the aggregate demand curve show?
the quantity of goods and services (real GDP) demanded at different price levels
deadweight loss
the reduction in total surplus resulting from a market not being in competitive equilibrium
normal profits
the return on capital necessary to keep investors satisfied and keep capital in the business over the long run
macroeconomics
the study of economy-wide phenomena, including inflation, unemployment, and economic growth
economic costs
the sum of explicit (out-of-pocket) and implicit (opportunity) costs
total cost
the sum of fixed costs plus variable costs-- all costs associated with running a business, including out-of-pocket expenses and opportunity costs
tragedy of the commons
the tendency for a resource that has no price to be used until its marginal benefit falls to zero
short run
the time period in which at least one input is fixed
short run
the time period when plant capacity and the number of firms in the industry cannot change. (nobody can enter or leave the market)
explicit costs
those expenses paid directly to another economic entity, including wages, lease payments, taxed, and utilities
primary determinant of price elasticity of supply
time
long run
time period is long enough for plants to alter their capacities and for the number of firms in the market to change.
average fixed cost
total fixed cost divided by the quantity of output
labor force
total number of those employed and unemployed
profit
total revenue minus total cost
informal economy
transfers of money, goods, or services that are not reported to the government (black market)
complements
two goods that are bought and used together. have a negative cross elasticity of demand
structural unemployment
unemployment caused by changes in the structure of consumer demands or technology
frictional unemployment
unemployment resulting from workers who voluntarily quit their jobs to search for better positions
cyclical unemployment
unemployment that results from changes in the business cycle
price system
uses monetary prices as a message system to facilitate exchanges between buyers and sellers
real GDP vs nominal GDP
using real GDP instead of nominal GDP allows a country to compare growth from year to year w/o having to account for inflation
demand for public goods graph
vertical summation of individual demand curves
government spending
wages/salaries of govt employees, the purchase of products and services from private businesses and the rest of the world, and purchases of new structures and equipment
determinants of consumption and saving
wealth, expectations, household debt, and taxes
crowding-out effect
when deficit spending requires the government to borrow, interest rates are driven up, reducing consumer spending and business investment.
price elasticity and total revenue along a straight-line (linear) demand curve
when price falls from 20 to 18, revenue rises, but as we move down the demand curve, elasticity equals one (unitary) and after that, when price falls, revenue declines
shutdown point for perfectly competitive firm
when price in the short run falls below the minimum point on the AVC curve
why is the aggregate demand curve downward sloping?
when price levels rise, the purchasing power of money falls (wealth effect)
total revenue and relatively elastic demand
when products have an elastic demand, it is usually because substitutes are available, so firms feel a greater impact from changes in price. A small rise in price causes sales to fall off dramatically.
economies of scale
when the average total cost declines with increased production
allocative efficiency
when the mix of goods being produced represents the mix that society most desires
total revenue and relatively inelastic demand
when the price rises, revenue rises because the revenue gained from the price hike is greater than the revenue lost from fewer sales
in a perfectly competitive firm, when does the firm maximize profits?
where MC=MR
underemployed workers
workers who are forced to take jobs that do not fully utilize their education, background, or skills
marginally attached workers
workers who were available to work and actively looked for it during the last 12 months, but not in the last four weeks
aggregate production function
y=Ak^(1/3)h^(2/3)
how does a change in taxes affect a change in income?
ΔY=[MPC/(1-MPC)]ΔT
