Macroeconomics Final Exam

reserve requirements

rules set by the Federal Reserve that determine the minimum reserve ratio for a bank.

Medium of exchange

something people accept as payment for goods and services (an asset that individuals acquire for the purpose of trading rather than for their own consumption)

Implicit liabilties

spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics

Reserve ratio

the fraction of bank deposits that a bank holds as reserves (reserves/deposits)

federal funds rate

the interest rate determined in the federal funds market

If the tax is not a lump-sum tax, the tax revenue will depend on:

the level of real GDP (and reduce the size of the multiplier)

Potential output

the level of real GDP the economy would produce if all prices, including nominal wages, were fully flexible

discount rate

the rate of interest the federal reserve charges on loans to banks normally this is set 1 percent more than the federal funds rate to discourage banks from turning to the feds when they are in need of reserves

monetary base

the sum of currency in circulation and bank reserves

Debt

the sum of money a government owes at a particular time

Planned aggregate spending =

the total amount of planned spending in the economy. C + Planned Investment

money supply

the total value of financial assets in the economy that are considered money currency in circulation + checkable bank deposits

Fractional reserve banking system

when you deposit money in a bank account, the bank is required to hold a part of it in its vault as cash, or else in an account with the regional federal reserve bank. They use the rest of the money to make loans.

What causes the SRAS curve to shift right?

Decrease in commodity prices Decrease in nominal wages Increase in productivity Each of these increases producers' profits and shifts the curve right

bank run

a phenomenon in which many of a bank's depositors try to withdraw their funds because they fear a bank failure. contagious

t-account

a tool for analyzing a business's financial position by showing their assets and liabilities

federal funds market

allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves

discount window

an arrangement in which the federal reserve stands ready to lend money to banks in trouble

M2

includes near-moneys

M1

includes only the most liquid forms of money

A fall in the aggregate price level of the LRAS...

leaves the quantity of the aggregate output supplied unchanged in the long run. The price level in the long run does not affect the aggregate output supplied.

Unit of account

money provides a yardstick for measuring and comparing the values of a wide variety of goods and services

Fiat money

money whose value derives entirely from its official status as a means of payment

capital requirements

requirement that the owners of banks hold substantially more assets than the value of bank deposits

What does a movement down the aggregate demand curve lead to?

A lower aggregate price and higher aggregate output

Lump-sum taxes

Taxes that don't depend on the taxpayer's income

Output gap

The % difference between actual aggregate output and potential output

Total increase in GDP calculation

(1 / 1-MPC ) x (amount of increase in investment spending)

Output gap formula:

(Actual - potential) / potential all times 100

Assumptions for the income-expenditure model

- Changes in overall spending lead to changes in aggregate output - The interest rate is fixed - Taxes, government transfers, and government purchases are all zero - Exports and imports are both zero

What drives planned investment spending?

1. The interest rate 2. Expected future real GDP 3. Current level of production capacity

Keynesian cross diagram

A diagram that identifies income-expenditure equilibrium as the point where a planned aggregate spending line crosses the 45 degree line

Interest rate effect

A higher aggregate price level makes households hold more money and leads to a rise in interest rates (and a fall in investment spending and consumer spending)

Wealth effect

A higher aggregate price level reduces the purchasing power of households' wealth and reduces consumer spending

Accelerator principle

A higher rate of growth in real GDP leads to higher planned investment spending. A lower growth rate of real GDP leads to lower planned investment spending.

The multiplier

A multiplier shows how initial changes in spending lead to further changes. It helps us understand chain reactions and how much extra income and spending are created from a initial change in spending. 1/(1-MPC) OR ΔY/ΔAAS

Income-expenditure equilibrium

Aggregate output (real GDP) is equal to planned aggregate spending

Consumption function

An equation showing how an individual household's consumer spending varies with the household's disposable income. c = a + MPC x yd c = household consumer spending a = constant, autonomous consumer spending yd = household's disposable income

Cyclically adjusted budget balance

An estimate of the budget balance if the economy were at potential output This is used to separate the effects of the business cycle from the effects of discretionary fiscal policy

ΔAAS

Autonomous change in aggregate spending.

Why does the SRAS curve slope upward?

Because nominal wages are sticky in the short run.

Aggregate consumption formula

C = A + MPC x YD

ΔY

Change in Real GDP (1/1-MPC) x ΔAAS

2 possible sources of a shift of the planned aggregate spending line

Change in interest rate and change in wealth

What causes shifts of the aggregate consumption function?

Changes in expected future disposable income and changes in aggregate wealth

What causes the SRAS curve to shift?

Changes in: Commodity prices, nominal wages, and productivity Each of these factors changes producers' profits and therefore shifts the SRAS

Does a change in wealth move us along the aggregate demand curve or shift it by the wealth effect?

Depends on the source of the change in wealth. Change in price level: movement along Change in something else: shift

The aggregate demand curve shifts because of changes in:

Expectations, wealth, size of the existing stock of physical capital, and government policies (monetary and fiscal)

Contractionary fiscal policy

Fiscal policy that decreases aggregate demand - brakes for the economy ex: reduction in government purchases of goods and services, increase in taxes, and reduction in government transfers Can close an inflationary gap

Expansionary fiscal policy

Fiscal policy that increases aggregate demand - extra fuel for the economy ex: Increase in government purchases of goods and services, cut in taxes, and increase in government transfers Can close a recessionary gap

Social insurance programs

Government programs (transfer payments) intended to protect families against economic hardship Ex: medicare

Marginal propensity to consume (MPC)

How much consumers spend when they receive more income. Change in consumer spending / Change in disposable income

Holding everything else constant, the multiplier effect for taxes or transfers:

I smaller than the multiplier effect for changes in autonomous aggregate spending

What happens when there is a shock on the economy?

If a demand or supply shock hits the economy, aggregate demand or SRAS shifts and moves the economy to a new short-run equilibrium

Aggregate demand curve

Illustrates the relationship between the aggregate price level and the quantity of aggregate output demanded in the economy

Aggregate supply curve

Illustrates the relationship between the aggregate price level and the quantity of aggregate output supplied in the economy

Current disposable income

Income after taxes are paid and government transfers are received

What causes the SRAS curve to shift left?

Increase in commodity prices Increase in nominal wages Decline in productivity Each of these decreases the producer's profits

Who introduced the multiplier idea?

John Meynard Keynes

Change in consumer spending =

MPC x change in disposable income

Store of value

Money is a means of holding purchasing power over time - enables people to save the money they earn today and use it to buy the goods they want tomorrow

Stick wage:

Nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labor shortages

Government transfers

Payments by the government to households for which no good or service is provided in return

Aggregate consumption function

Shows how current disposable income affects consumer spending. Relationship for the economy as a whole between aggregate disposable income and aggregate consumer spending.

Long run aggregate supply curve

Shows the relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages, were fully flexible.

Holding everything else constant in an economy, the larger the MPS, the: _____ the value of the multiplier

Smaller.

Government saving (Surplus) =

Tax revenues - government purchases - transfers

Stagflation

The combination of inflation and falling aggregate output that comes with a negative supply shock

What is planned investment spending?

The investment spending that businesses intend to undertake during a given period

Income-expenditure equilibrium GDP:

The level of real GDP at which real GDP equals planned aggregate spending

Actual investment spending

The sum of planned investment spending and unplanned inventory investment

What is "long run" referred to?

The time it takes for all prices (including nominal wages) to adjust. However, there is not a change to profits just because prices have changed.

Stabilization policy

The use of government policy to reduce the severity of recessions and rein in excessively strong expansions

Fiscal policy

The use of taxes, government transfers, or government purchases of goods and services to shift the aggregate demand curve. Ex: Tax cuts

Inventory investment

The value of the change in total inventories held in the economy during a given period

What can we look at to explain and predict the economy's behavior? (ex: recessions, inflations)

Total (aggregate) demand and total (aggregate) supply

Unplanned inventory investment

Unplanned changes in inventories occurring when actual sales are more or less than businesses expected

AD-AS model

Uses the aggregate supply curve and the aggregate demand curve together to analyze economic fluctuations

Why does a rise in the aggregate price level reduce consumer spending, investment spending and exports minus imports? (Why does the AD curve slope downward?)

Wealth effect and the interest rate effect

Marginal propensity to save (MPS)

Whatever is not spend with the MPC is saved. The fraction of an additional dollar of disposable income that is saved. MPS = 1 - MPC

Inflationary gap

When aggregate output is above potential output

Recessionary gap

When aggregate output is below potential output

Long-run macroeconomic equilibrium

When the point of short-run macroeconomic equilibrium is on the long-run aggregate supply curve

What levels of GDP is unplanned inventory investment positive?

Wherever GDP is greater than aggregate spending planned

excess reserves

a bank's reserves over and above its required reserves (we assume banks don't want to hold excess reserves)

federal reserve

a central bank that oversees and regulates the banking system and controls the monetary base

demand deposits

a deposit of money that can be withdrawn without prior notice

Commodity money

a good used as a medium of exchange that has intrinsic value in other uses ex: cigarettes in prison

deposit insurance

a guarantee that a bank's depositors will be paid even if the bank can't come up with the funds. (the FDIC currently guarantees the first 250,000 of each account)

Commodity-backed money

a medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods

Money must function as:

a medium of exchange, a store of value, and a unit of account

Monetary aggregate

an overall measure of the money supply

Discretionary fiscal policy

arises from deliberate actions by policy makers rather than rules

checkable bank deposits

bank accounts on which people can write checks

open-market operations

buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system, facilitated by the federal reserve

currency in circulation

cash held by the public

A movement down the short-run aggregate supply curve leads to:

deflation and lower aggregate output

why does the money multiplier decrease when you increase the percentage of bank deposits?

ex: bank deposits = 1000 if original percentage is 10, then the amount of bank deposits requires is 100. this means the money multiplier is (1000/100) if increased to 20, amount of bank deposits required is 200. this means money multiplier is (1000/200 = 5) <-- decrease

near moneys

financial assets that cant be directly used as a medium of exchange but can readily be converted into cash or checkable bank deposits

What commodity does the Federal Reserve choose to buy and sell daily?

government bonds, because they can be stored indefinitely and are easy to buy and sell on the open market Usually buys and sells short-term bonds called Treasury bills, or T-bills

Automatic stabilizers

government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands (unemployment insurance)

what is used to determine the money supply?

not only on the ratio of reserves to bank deposits but also on the fraction of the money supply that individuals choose to hold in the form of currency

Holding everything else constant, the government's deficit

tends to increase during a recession and will increase if the government purses expansionary fiscal policy

money multiplier

the amount of money that banks generate with each dollar of reserves formula = (bank deposits/amount of required reserve) ratio of the money supply to the monetary base

bank reserves

the currency that banks hold in their vaults plus their deposits at the Federal Reserve

Deficit

the difference between the amount of money a government spends and the amount it receives in taxes over a given period

Nominal wage:

the dollar amount of the wage paid