Intermediate Macroeconomics Final Exam Study Guide
Intermediate Macroeconomics Final Exam Study Guide ECON 3020
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This 7 page Study Guide was uploaded by Zachary Hill on Wednesday April 27, 2016. The Study Guide belongs to ECON 3020 at Tulane University taught by Antonio Bojanic in Fall 2015. Since its upload, it has received 47 views. For similar materials see Intermediate Macroeconomics in Economcs at Tulane University.
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Date Created: 04/27/16
ECON 3020 Study Guide for Exam #3 Exam Outline 1. IS curve 2. MP curve, IS curve, and AD curve 3. Okun’s Law, PC , and AS curve 4. Graphical analysis of AD curve and AS curve 5. Analysis of AD curve and AS curve utilizing simple equations InvestmentSavings Curve ● The IS curve shows the relationship between real interest rates, r, and aggregate output, Y , when the economy is experiencing goodsmarket equilibrium PE ● Aggregate planned expenditure, Y , equals Y at goodsmarket equilibrium PE ● Y = C + I + G + NX ○ C = C + MPC(Y − T) − cr where C is autonomous consumption, MPC is the marginal propensity to consume, Y − T is disposable income, and c is the sensitivity in changes in savings with regards to r; when r increases, savings are more attractive, so consumption spending decreases, and vice versa ○ I = I − dr where I is autonomous fixed investment and d is the sensitivity in changes in investment with regards to r; when r increases, borrowing decreases, so investment spending decreases, and vice versa ○ NX = NX − xr where NX is autonomous net exports and x is the sensitivity in changes in net exports with regards to r; when r increases, the domestic currency trades at a higher rate with foreign currencies, so exports become more expensive to the foreign economies (exports decrease) and imports become cheaper to the domestic economy (imports increase) (net exports decrease) ○ G = G where G is autonomous government expenditures; taxes are also exogenous, so T = T ○ Y = C + I + G + NX at goods market equilibrium Y = C + MPC(Y − T) − cr + I − dr + NX − xr + G Y = C + MPC ∙ Y − MPC ∙ T − cr + I − dr + NX − xr + G Y − MPC ∙ Y = C + I + NX + G − MPC ∙ T − r(c + d + x) Y (1 − MPC) = C + I + NX + G − MPC ∙ T − r(c + d + x) Y = (C + I + NX + G − MPC ∙ T)1−MPC − r1−MPC ; this is the IS curve equation ● ● When C , I, NX, or G increase, the IS curve shifts upward; when C, I, NX , or G decrease, the IS curve shifts downward ● When T increases, the IS curve shifts downward; when T decreases, the IS curve shifts upward The Monetary Policy Curve ● The MP curve shows the relationship between the interest rates the Fed sets (through the Federal Funds Rate) and the economy’s inflation rates, π ● The MP curve equation is given by r = r + λπ, where r is the interest rate that would occur when there is no inflation and λ is the sensitivity of r to changes in π ● ● The Fed chooses to increase r when π increases because of the Taylor principle, which states that when the π increases, an economy’s central bank will increase r because in times of high inflation, if left unattended, r will decrease, causing Y to increase, causing π to continue to increase, and the cycle would continue ● Changes in r can occur in two ways ○ Automatic changes in r occur when π changes and the Fed follows the Taylor principle, moving along the MP curve ○ Autonomous changes in r occur when the Fed changes r, shifting the MP curve up or down Aggregate Demand ● AD is the total amount of goods and services that an economy will demand at a given price level ● We look at this as how will the total demand for goods and services in an economy vary each period with different levels of inflation ● Combining the IS curve and MP curve, we can derive the AD curve ● ● For the equation of the AD curve, you can plug the MP curve equation into the IS curve equation: Y = (C + I + NX + G − MPC ∙ T) 1 − (r + λπ)c+d+x 1−MPC 1−MPC ● When C , I, NX, or G increase, the AD curve shifts upward; when C, I, NX , or G decrease, the AD curve shifts downward ● When T or r increases, the AD curve shifts downward; when T or r decreases, the AD curve shifts upward The Phillips Curve ● The PC is split between the short run and the long run ● The shortrun PC shows the inverse relationship between the unemployment rate and π ○ ○ This is given by the equation π = π − w(U − U )n+ P where π is the expected inflation rate (often times the rate of the year before), w is the sensitivity of π to changes in the unemployment gap, U is the actual rate of unemployment, U is n the natural rate of unemployment, and P is supply shocks that shift the PC ● The longrun PC , or LRPC , is inelastic at U nbecause the economy will tend toward this rate in the long run, regardless of π ● Okun’s Law ● Using the LRPC , we can see that if U does not change in the long run then the economy’s level of production should not change in the long run; this is called potential output, Y p ● Okun discovered that there is an inverse relationship between the output gap, Y − Y ,p and the unemployment gap, U − U n ● The specific equation for this relationship in the US is approximately (U − Un) =− 0.5(Y − Yp) ● Aggregate Supply ● AS is the total amount of goods and services produced within an economy at a given price level ● We look at this as how will the total supply for goods and services in an economy vary each period with different levels of inflation ● Applying Okun’s Law to the PC and LRPC we can derive the AS curve ● The shortrun AS curve, or SRAS curve, takes the PC and replaces the unemployment gap with the sensitivity of the unemployment gap to changes in the output gap; then the SRAS curve equation is found as follows e π = π − w(U − U ) n P π = π − w(− 0.5(Y − Y ))p+ P π = π + 0.5w(Y − Y ) p P , change 0.5w to γ, the sensitivity of π to the output gap e π = π + γ(Y − Y )p+ P ○ ○ When π or P increase or Y − Y > 0, phe SRAS curve shifts upward; when π or e P decrease or Y − Y < 0p the SRAS curve shifts downward ● As we observed earlier, since the economy tends toward U in the long run, it will tend n towards Y ip the long run; from this you can see that the longrun AS curve, or LRAS, will be inelastic at Y p ○ ○ When U denreases Y increapes shifting the LRAS curve rightward; when U n increases Y dpcreases shifting the LRAS curve leftward ○ When L , K, or A increase, the LRAS curve shifts rightward; when L, K , or A decrease, the LRAS curve shifts leftward ○ The LRAS curve shifts rightward overtime because L, K , and A almost always increase in the long run Combining Aggregate Supply and Aggregate Demand ● When we combine the graphs of the AS curves and the AD curve, we are able to discover the equilibrium π and Y at the point where the curves intersect, both in the long run and the short run; they will always tend to the same point (longrun equilibrium) but it is possible for the shortrun equilibrium to be different ● ● To find the equilibrium points for actual economies, you need the equations for both; you then plug one equation into the other, solve for the variable, plug the known variable into one of the original equations, and solve for the remaining variable ● If longrun equilibrium and shortrun equilibrium differ, in the longrun the SRAS curve will shift due to persistent output gaps (Y / Yp ) until Y = Yp; this is called the self correcting mechanism ● If the shortrun equilibrium occurs at a point where Y < Yp then the economy is underproducing and has a U > U ; nhe self correcting mechanism will fix this over time, but the government may feel it should be corrected quicker; then the government must shift the AD curve left by either decreasing T or increasing G or both; the government must weigh doing this against the higher inflation rate this action will incur
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