exam 2 study guide
exam 2 study guide ECON 104
Popular in Introductory Macroeconomic Analysis and Policy
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This 8 page Study Guide was uploaded by Julia Staltari on Friday March 20, 2015. The Study Guide belongs to ECON 104 at Pennsylvania State University taught by Adrienne Kearny in Spring2015. Since its upload, it has received 178 views.
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Date Created: 03/20/15
O O O OO O Econ 104 exam 2 when economy is at potential cyclical unemploymentO gt caused by recession structural and frictional never O Unemployment never equals zero always exists discouraged worker available for work but have not look for a job during the past month marginally attached want a job but have given up unemployment rate number unemployedlabor force X 100 labor force unemployed employed population ratio fraction of the population that has jobs employedworking age population x 100 participation rate o of population in the labor force labor force working age population x 100 on the decline bc retirement disabled americans discouraged of students working age population 1664 years U6 U marginally attached workersdiscouraged workers part time workers who want full time marginally attached neither working or look for work but want a job whv did policy makers come up with U6 because unemployment doesn t reflect OIIIO 00 OO discouraged or part time who want full time U rate can fall bc workers dropped outdiscouraged or only part time jobs are available they want full time inflationpi calculated by Consumer Price Index CPI pi rate o change in price level disinflation pigt 0 but falling often seen when economy slows deflation pilt 0 money illusion don t take into account inflation when we look at our money which declines the value of the dollar price levels GDP deflator focuses on all goods and services produced in the US consumer price index CPI focuses on just consumer goods 70 measure of the average change over time from base year to current year in the prices of goods and services purchased by the typical urban family of four fixed CPI cost in current year cost in base year x 100 CPI in base vear 100 OOOO OIIOOIIO OIIOIIII O O inflation and purchasing power as CPI increases purchasino bower decreases amount of goodsservices the dollar can buy if CPI gt 100 the real purchasing power of the dollar has decreased since the base year if CPI lt 100 the real purchasing power of the dollar has decreased since the based year ex how much would babe ruth s salary be now was 80000 is now 1467907 consequences of inflation inflation shrinks income inflation pi newold old x 100 real income yearx nominal income CPI yearx100 nominal income actual income received real income adjusted for inflation income adjusted for changes in the CPI Growth in real shows increase in purchasing power and standard of living as inflation rises real income falls change in real income o change nominal income change CPIpi inflation hurts most when it is unanticipated bc we can t adjust inflation burns americans on fixed income bc their income stays the same while inflation changes interest rate cost of borrowing and the return to lending nominal interest rate the stated interest rate on a loan saving account certificate of deposit CD is observable irm when it asks for nominal use i can never be negative real interest rate r is not observable inflation increases real rates r pi rate can be positive or negative when inflation increases base year CPI is always 100 unanticipated inflation don t like bc we can t adjust it better to be a borrower because as inflation rises the real rate falls lenders and savers lose in an inflation situation purchasing power declines when r lt 0 lenders and savers lose interest earnings do not keep up with inflation borrowersonly paying the real value back bank is essentially paying you to borrow real interest rate is negative when r lt 0 borrowers win They pay back less in real terms O OO 00 I OO 0 000 when rquote lt 0 you are more likely to spend when rquote gt 0 you are more likely to save business cycle alternating periods of economic growth and contraction which can be measured by changes in real GDP expansion production employment and income are increasing spending by firms and by households increases peak the expansion ends recession production employment and income decline spending by firms and households decHnes when was the last recession in the US december 2007 June 2009 trough the recession ends one cycle peak to peak NBER national bureau of economic research how we know we re in recession business cycle dating committee announces when recession begin and end takes time to gather and analyze economic data contractionrecession don t know how long it will last Challenges in forecasting business cycles no two business cycles are alike they vary in length and depth RGDP only comes out quarterly need more than this to predict policymakers need to anticipate recession or boom economic indicators a statistic about an economic activity allow analysis of economic OO IIO performance and predictions of future performance Business cycle indicators refer to RGDP released more frequently than RGDP Lead lag or are coincident indicators of the RGDP cycle counter cyclical troughs during a peak and peaks during a trough have cvcles but mav differ in timing and direction direction economic variable can be procyclical countercyclical or acyclical timing timing of peaks and troughs of the business cycle indicator w respect to RGDP peak s and troughs leading coincident lagging IIIO IIO COOIIIOII IO 0 0 GOO 000 leading indicators peaks and troughs occur before peaks and troughs ex customer confidence survey HH about future spending plays stock prices procyclical and leading PampT before RGDP coincident indicators peaks and troughs occur at the same time as RGDP peaks and troughs ex unemployment industrial production employment consumption and investment employment procyclical and coincident unemployment is the only countercyclical we will see lagging indicators peaks and troughs occur after RGDP peaks and troughs inflation procyclical and lagging when RGDP reaches a trough in the business cycle stock prices will continue to rise while emplovment will start to rise international aspects of business cycles we tend to all move together contagion what causes business cycles shocks to aggregate demandsum up all the demand sudden change in wealth ex decrease in home value pessimism or optimism about the future change in the gov policy AD C G NX decrease consumption expenditures decrease gt surplus shocks to the aggregate supply AS ex sudden change in the price of oil factors of production inventions or innovations ex internet and it s affect on potential production excess demand for goods gt shortage LRAS long run aggregate supply real GDP supplied in the long run aka potential SRAS short run aggregate supply quantity of RGDP supplied by firms in short run GDP gap Y Ybar potential RGDP on PPF gt output at full employment A shock to AD pessimism about the future surplus unemployment increases and incomes decrease decrease in consumption expenditures output Y falls price level P falls GDP gap is negative A shock to AS oil price shock excess demand for goods shortage output Y falls price level P increases pi gt 0 GDP gap negative O 0000 O O O OO O O shocks are transmitted abroad through trade amp financial markets gt 2 channels trade decrease in imports C investment expenditures decrease in european exports financial markets decrease in US in HH wealth and stock prices gt decrease C and AD in europe decreased demand for european exports decrease in AD recession Great recession of 20072009 HH lost 7 trillion in stock market wealth and in real estate With increased globalization shocks that cause business cycles are easily transmitted to the ROW bc of highly integrated markets Market for loanable funds as R interest rates increase you want to save demand of loanable funds represents net borrowers HH firms negatively related to r supply of loanable funds represents net saverslenders HH firms gov increase related to the real interest rate gov budget surplus increase in HH and gov spending federal reserve increases the suoplv of funds by increasing the money supply increase in RGDP on loanable funds market increased economy firms and households are more willing to borrow bc of improved outlook increase in gov deficit the supply of loanable funds shifts to the left and real rates fall an increase in the demand shift for loanable funds increases the real rate shortage an increase in the supply of loanable funds decreases the real interest rate surplus aggregate expenditure measure of income present value of all finished goodsservices sum of every expenditure in an economy during a certain time aggregate demand total demand for every finished goodservice number of goods bought at every price level how the great depression affected the economy RGDP fell 30 unemployment rose to 25 stock prices fell HH wealth plummeted business close banks failed Classical theory prior to the great depression primarily based on microeconomic theory laissezfaire economy would correct itself recessions are only temporary gov shouldn t intervene bc it will always find equilibrium 0 IO 0 IIO GOO GOO Keynesian theory the economy was not self correcting if spending is inadequate the economy won t reach full employment on its own short run matters policy makers should step in to help restore full employment consumption C C a bYd Yd disposable income YTTr T taxes TRtransfers social security benefits MPC marginal propensity to consume b slope wealth assetsliabilities wealth IS NOT income Assets equity what you ve paid off land house shares of stock bond gold cars etc are stocks and bonds part of wealth they are financial securities Liabilities your debt mortgage loan credit card debt etc change in taxes a decrease in income taxes T increases Yd and C increases c function moves up when taxes are cut disposable income increases moves along the C function along with change in disposable income Yd change in wealth when W increases the C function shifts up autonomous consumption the level of consumption which does not depend on income The DO 000 OD argument is that even with zero income you still need to buy enough food to eat through borrowing or running down savings Change in expected future income Ye Consumer confidence CC is a good proxy for Ye lf CC is increasing the C function shifts upward Two measures index of CC and index of consumer sentiment Change the price level if the price level increases real wealth decreases and the C function shifts downward Real wealth nominal wealth CPI100 o change is positive inflation change in the real interest rate cfr if the real rate decreases C shifts upward if i goes down borrowing goes up real value of savings falls bc prices rise you re paying the bank a storage fee purchasing power declines when real rates are negative when inflation is negative real rates increase real disposable income not consumed is saved wall street journal video they re being patient with interest rates june vs september doesn t really matter going to go less aggressive than planned when inflation is to 2 they will increase but it s going down now because of energy prices marginal propensity to save MP8 change in saving change is disposable income marginal propensity to consume the slope of the consumption function the amount by which 0 0 GOOD 0 O 00 CO OO 0 consumption spending changes when disposable income changes if you know the MPC you can solve for the MPS MPCMPS 1 change in capital stock investment Aggregate expenditure AE C l G NX AD investment expenditures I gt physical investment 17 of RGDP includes spending by firms on capital goods Investment demand curve vertical axis r slope negative because if there is a lower rate more firms will expand investment change in capital stock when we grow investment fell over the great recession nation can accelerate economic growth standard of living increases by increasing the capital stock investment demand negative slope lower rate and more firms will expand factors that affect the function change in the real interest rate move along I demand curve shift in the I demand change in expectations of future profitability technological change stay on the cutting edge or you can39t compete change in business taxes change in real interest rate a firm will undertake invest if Expected real return on is gt or equal to interest cost 0000 9955 EDP cameo change expectations of future profitability EFP reflect firms confidence in the future optimistic I demand shifts right pessimistic I demand shift left Keynes is driven by animal spirits which reflect business confidence Current Events Fed puts interest rates hikes in play dropped the word patient which means they will consider at their June 1617 meeting the fed is concerned about low inflation officials revised down their projections of economic growth in the coming years the fed revised down unemployment at potential full employment output to the range of 5 to 52 US adds Jobs at steady clip but the wage growth remains soft number of new jobs in feb 295000 this was greater than expectations of economists that were surveyed hiring was strong across most industries unemployment rate fell to 55 U6 unemployment rate fell to 11 in feb wages were up only 2 labor force participation rate fell to 628 in feb the figure is near the lowest level since the 1970 s cyclical weakness persists
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