Exam 3 Study Guide
Exam 3 Study Guide ECON103011
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This 5 page Study Guide was uploaded by Michael Notetaker on Tuesday April 26, 2016. The Study Guide belongs to ECON103011 at University of Delaware taught by Professor Abrams in Winter 2016. Since its upload, it has received 133 views. For similar materials see Macroeconomics in Economcs at University of Delaware.
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Date Created: 04/26/16
Ryan Cleary 4/28/16 Exam 3 Study Guide Chapter 11 • Planned investment-the amount firms plans to invest • Investment schedule-a table of numbers that shows the amount firms plan to invest at various possible values of real GDP • Investment only changes with expected rate of returns and stays constant over changes in real GDP (greater rate of real interest rates or rate of returns the greater the investments) • Aggregate expenditures schedule-a table of numbers showing the total amount spend on final goods and final services at different levels of real GDP (=Consumption + investment) • Equilibrium GDP occurs when C + I g GDP = aggregate expenditures o When equilibrium is not met and aggregate expenditures is less than GDP, inventory would increase by the difference (output is greater than consumption) o If GDP is less than aggregate expenditures, inventory would decrease by the difference and it would be considered unplanned investment (output is less than consumption) o Graphical approach-equilibrium occurs when aggregate expenditures intersects the 45- degree line on the real GDP vs. aggregate expenditures graph • Leakage-withdrawal of potential spending from the income-expenditures stream via savings, tax payments or imports, a withdrawal that reduces the lending potential of the banking system, leads to a decline in total output because GDP is greater than consumption • Injection-an addition of spending to the income-expenditures stream, a potential replacement for leakage o If injection is greater than leakage, then consumption will be greater than GDP • Unplanned changes in inventories-changes in inventories that firms did not anticipate, changes that occur because unexpected increases/decreases in consumption, failure of spending to match output therefore firms add/remove to/from their inventory • Multiplier = ∆ in output / ∆ in investment (resulting from a change in the rate of return of real interest rate) • Net exports = exports – imports o Exports will have similar effects as an increase in investment, increases/decreases equilibrium GDP by the net export times the multiplier o ∆ in equilibrium GDP = net export X multiplier • Tariffs can be put in place to increase GDP by suppressing imports, however this leads to retaliation by other countries putting tariffs on our exports leading to minimal change • Government purchases must be accounted for when looking at equilibrium GDP and must be subjected to the multiplier similarly to net exports and changes in investment • Equilibrium GDP o GDP = aggregate expenditures = consumption + investment spending + net exports + government purchases = C + I + X + G a g n o Consumption = GDP – taxes – savings = disposable income – savings • Lump-sum tax-a tax that collects a constant amount (the tax revenue of government is the same) at all levels of GDP • Recessionary expenditure gap-the amount by which the aggregate expenditures schedule must shift upward to increase real GDP to its full-employment, noninflationary level o Keynes’ solution-increase government spending, a $5 increase in G can increase GDP by $20 because of the multiplier • Inflationary expenditure gap-the amount by which the aggregate expenditures schedule must shift downward to decrease the nominal GDP to its full-employment noninflationary level Chapter 12 • Aggregate demand-a schedule or curve that shows the total quantity of goods and services that would be demanded at various price levels (as the price level decreases, real GDP increases, inverse relationship) o Real balance effect-the tendency for increases in the price level to lower the real value (or purchasing power) of financial assets with fixed money value and as a result to reduce total spending and real output and conversely for decreases in price level (higher price level means your money doesn’t go as far and is less effective and therefore you won’t purchase as much) o Interest-rate effect-the tendency for increases in price levels to increase the demand for money, raise interest rates, and as a result reduce total spending and real output in the economy (increases the interest rates, increases the demand for money and since there is only so much money, real output demanded falls) o Foreign purchases effect-the inverse relationship between net exports of an economy and its price level relative to foreign price levels (as the price level rises and the exchange rate stays constant foreigners will buy less of our exports) • Determinants of aggregate demand-factors such as consumption spending, investment, government spending, and net exports that if they change shift the aggregate demand curve o Consumer spending-if consumers decide to buy more at each level of output curve will shift right § Consumer wealth-sudden increases in the perceptions of people’s wealth leads to a shift right (housing market increase, stock market boom) § Household borrowing-as households borrow more money spending increases, as savings increase to pay off debt spending decreases § Consumer expectations-expectations about future real income affects spending § Personal taxes-a decrease in taxes increase disposable income and increases spending o Investment spending-a decline in investment spending will shift the aggregate demand curve to the left § Real interest rates-an increase in the money supply lowers the interest rates and increases investment spending shifting aggregate demand right § Expected returns-lower expected returns decreases investment spending o Government spending-increases in government spending will shift curve right o Net export spending-increases in exports shifts aggregate demand curve right § National income abroad-when incomes of other countries increase they spend more and buy more of US exports shifting curve right § Exchange rates-when the rate of exchange from euros to dollars decreases (more dollars per euro) the dollar can go further for foreigners and exports will increase shifting curve to the right • Aggregate supply-a schedule or curve showing the total quantity of goods and services that would be supplied (produced) at various price levels o Immediate-short-run aggregate supply curve-an aggregate curve for which real output, but not price level, changes when the aggregate demand curve shifts; a horizontal aggregate supply curve that implies an inflexible price level o Short-run aggregate supply curve-an aggregate supply curve relevant to a time period in which input prices (particularly nominal wages) do not change in response to changes in price level (up-sloping curve with increasing slope because above full-employment per- unit production cost greatly increases) o Long-run aggregate supply-the aggregate supply curve associated with a time period in which input prices (especially nominal wages) are fully responsive to changes in price level, real GDP does not change on the price level changes • Determinants of aggregate supply-factors such as input prices, productivity, and the legal- institutional environment that, if they change, shift the aggregate supply curve o Input prices § Domestic resource prices-increases in wages shift the curve left § Prices of imported resources-decreased prices in US imported resources shifts the curve right o Productivity = total output / total inputs § Per-unit production cost = total input cost / total output § A decrease in per-unit cost/productivity shifts the curve right o Legal institutional environment § Business taxes and subsidies-as taxes increase the productivity decreases and the curve shifts left § Government regulation-more regulation leads to more costs and shifts curve left • Equilibrium price level-the price at which aggregate demand equals aggregate supply, the price level at which the two lines intersect and this corresponds to a specific equilibrium real output • Changes in equilibrium o Increases in AD: demand-pull inflation-equilibrium price level and output are higher o Decreases in AD: recession and cyclical unemployment-equilibrium output is decreased while price levels tend to stay constant § Fear of price war § Menu costs-the reluctance of firms to cut prices during recessions (that they think will be short-lived) because of the costs of altering and communicating their prices reductions (named after cost of printing new menus at restaurants to displaying changing prices) § Wage contracts-cutting prices only leads to increases in revenue if wages are cut too and contracts keep wages steady § Efficiency wages-an above-market wage that minimizes wage costs per unit of output by encouraging greater effort or reducing turnover, and thus decreases wages leads to a lowering of productivity § Minimum wages-firms cannot lower prices lower than minimum wage o Decreases in AS: cost-push inflation-equilibrium price level is increased while real output is decreased o Increases in AS: full-employment with price-level stability Chapter 13 • Fiscal policy-changes in government spending and tax collections designed to achieve full employment, price stability, and economic growth • Council of Economic Advisors (CEA)- a group of three persons that advises and assists the president of the US on economic matters • Expansionary fiscal policy-an increase in government purchases of goods and services, a decrease in net taxes, or some combination of the two for the purpose of increasing aggregate demand and expanding real output o Budget deficit-the amount by which expenditures exceed revenues in any year o Increases in government spending experience the multiplier effect and a $5 increase in government spending can make up the $20 GDP gap o Personal tax cuts also go through the multiplier but more tax cuts must be implemented than government spending because some money cut from taxes is saved o Tax cuts and government can be used together to make reach equilibrium • Contractionary fiscal policy-a decrease in government purchases of goods and services, an increase in net taxes, or some combination for the purpose of decreasing aggregate demand and thus controlling inflation o Budget surplus-the amount by which the revenue of the federal government exceeds its expenditures in any year, caused by demand-pull inflation o Once a new price level is established, it will not move so the equilibrium GDP has to be shift to have the demand meet the higher price level at the GDP wanted o Book example-taxes must be increased or spending must decrease by $3 billion in order to get GDP back to $510 billion • Built-in stabilizer-a mechanism that increases government’s budget deficit (or reduces surplus) during a recession and increases government’s budget surplus (or reduces deficit) during an expansion without any action by policy makers (tax system) o Progressive tax-a tax for which the average tax rate rises with GDP o Proportional tax-a tax for which the average tax rate remains constant as GDP rises or falls o Regressive tax-a tax for which the average tax falls as GDP rises o The more the progressive the tax system, the greater the economy’s stability • Cyclically adjusted budget-the estimated annual budget deficit or surplus that would occur under existing tax rates and government spending levels if the economy were to operate at its full employment level of GDP for a year (compares actual government expenditures with the tax revenues that would have occurred if the economy had achieved full-employment GDP) • Cyclical deficit-deficit that occurs from a recession, not fiscal policies put in place by government (cyclical adjusted budget equals zero) • 2003 Bush cut taxes which increased output and employment • 2008 Congress pushed an economic stimulus package which cut taxes and delivered checks to taxpayers which lead to a jump in the federal budget (many people saved this money instead of spending it or paid off loans) • 2009 Congress used more money to stimulate economy with increased government spending • Problems of timing o Recognition lag-the delay between the time the beginning of the recession/depression and the time it takes to incorporate solutions o Administrative lag-the time it takes for the administration to take action and implement solutions o Operational lag-the time it takes for the implemented solutions to take affect • Political business cycle-fluctuations in the economy caused by the alleged tendency of Congress to destabilize the economy reducing taxes and increasing government expenditures before elections and to raise taxes and lower expenditures after elections • Crowding-out effect-a rise in interest rates and a resulting decrease in planned investment caused by the federal government’s increased borrowing to finance budget deficits and refinance debts • Public debt-the total amount owned by the federal government to the owners of government securities, equal to the sum of past government budget deficits less government budget surpluses • US government securities-US treasury bills, notes, and bonds used to finance budget deficits, the component of the public debt • Federal debt held by the public as a percentage of GDP in 2012 is 70% • Because 67% of the public debt is owned by Americans to minimize the debt Americans would have to pay higher taxes to give back to those Americans holding the debt o This would redistribute wealth from lower and middle class to wealthy groups increasing the income distribution • External public debt-the portion of the public debt owed to foreign citizens, firms, and institutions • Public investments-government expenditures on public capital (such as roads, highways, bridges, etc.) and on human capital (such as education, training, and health)
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