Econ 201 Exam 4 Study Guide
Econ 201 Exam 4 Study Guide ECON 201
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This 11 page Study Guide was uploaded by Ekene Tharpe on Monday May 2, 2016. The Study Guide belongs to ECON 201 at University of Tennessee - Knoxville taught by Donna Bueckman in Fall 2015. Since its upload, it has received 164 views. For similar materials see Intro Economics: Survey Course in Economcs at University of Tennessee - Knoxville.
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Date Created: 05/02/16
ECON 201 EXAM 4 STUDY GUIDE Unemployment Population divided into 3 groups: by BLS 1. Employed-‐ Paid employer, self-‐employed, and unpaid workers in a family business 2. Unemployed-‐ Non-‐working people that have been looking for work the past 4 weeks 3. Not in the Labor Force-‐ Everyone else (stay at home moms, full time students, retires) Unemployment Rate • Percentage of unemployment in the Labor Force • Also called U-‐Rate o = 100 * (# unemployed/ labor force) Labor Force Participation Rate • Percentage of the Adult Population in the Labor Force o = 100 * (labor force/ adult population Labor force based on “adult population”-‐ 16 years and older • Disincluding: military, institutionalized, incarcerated, minors Natural Rates of U • The normal rate of unemployment around the actual unemployment rate fluctuates o Made up of frictional and structural unemployment o The long run “average” • Unemployment Insurance: o Government program that provides funding to unemployed workers § Benefits: Reduce income uncertainty; increases search time; increases possibility of job that is a good fit, this increasing productivity § Costs: Increases frictional unemployment • Frictional Unemployment: o When workers are searching for a job that best suits their skills/taste o Short-‐term in most cases • Structural Unemployment: o The skills of the worker aren’t “valued” by the market o Occurs when there aren’t enough jobs in the market § Can be long-‐term § Can result from “sticky wages” Explaining Structural U: Policy W 1 : actual wage Occurs when wages are above equilibrium 1. Min Wage Laws: Price floor (mostly effects teen employment) W eqm 2. Unions: Worker association; collective bargaining w/ employers over wages, benefits, and working conditions 3. Efficiency Wages: Firms voluntarily pay higher than equilibrium wages to boost worker productivity Types of Unemployed People • Marginally Attached: person is neither working nor looking for work; person wants to work, is available, and has looked in the past 2 months. Is not included in U. • Discouraged Workers: person would like to work, but has stopped looking because of a, “given up on the job market” related reason. Identified as “Not in the Labor Force.” • Underemployment: person is working below their skill level. U-‐rate fails to show economy failure. The Official U Rate (U-‐3) and others: published by BLS • Statistics based on demographic information • Measured the length of U • Data shows drastically different labor market experiences for different groups (age, race, etc.) • Trends help policy makers make better polices o Caveat: Trends can inform, even if data flawed Yellen “Dashboard” • Top 3: 1. U-‐6: 2. Long-‐term Unemployed: 3. Labor Force Participation Rate: • Others: 4.) Quitting and Hiring, 5.)Wage and Growth Cost of Unemployment • Economic costs: o Present output: less workers, less capital (buildings) o Future output: future stream of output compromised • Social costs: o Magnified effect on person/family, increasingly negative affects Aggregated Demand and Supply Business cycles: • Short-‐run economic fluctuations around the long run trend § 4 phases: 1. Peak (Back to Peak) 2. Recession 4. Recovery 3. Trough Aggregate Demand and Aggregate Supply: The Model (short-‐run) The price Short-‐run Ag. Supply leve CPI) nk This model determines equilibrium price level and equilibrium level of 1 P Ag. Demand Y: of output (As GPD increase, so does 1 price and inflation) Y • AS/AD models both incorporate growth, inflation, and unemployment • Inflation pressure: o Can be because of right shift in AD or left shift in AS Say’s Law (Classicals): Supply Rules • If the supply is there, the demand will follow • Neoclassical Zone: o Eqm level of real GDP around potential GDP § Decrease in cyclical unemployment in this economy Keyne’s Law (Keyetians): Demand Rules • People’s willingness to pay first, then supply follows • Keynesian Zone: o Eqm level of real GDP around far below potential GDP o Economy in recession § Increase in cyclical unemployment Aggregate Demand (AD) Curve • AD curve shows the quantity of all G&S demanded in the economy at any given price level • Components of AD: o C, I, G, and NX (added together equals GDP) o Assume G is fixed policy • Slope of AD, how P affects C, I, and NX o Increase in P decreases the quantity of G&S demanded because of: • The wealth effect (decrease C) • The interest rate effect (decrease I) • The foreign policy/exchange rate effect (decrease NX) Decrease C, I, and NX P 2 P 1 Y 2 Y 1 • Shifts in AD o Shift outward as GDP components increase o Shifts left when the components decrease § Taxes increase, disposable income decreases Aggregated Supply • Relationship b/w the real GDP and the price level for output. The price of inputs is fixed Long-‐Run AS (Classical) Short-‐Run AS • Potential GDP = LRAS • Factors shifting SRAS curve: o Worker Productivity o Changes in price of key inputs § Technology o Discovery of a natural recourse: § Discover new mineral deposits § Decrease supply of importer oil § Long run changing weather patterns that affect production • Shift Left: o Combination of lower growth and higher inflation and unemployment • Shift Right: o Combination of higher growth and lower inflation and unemployment Why SRAS Slope Matters SRAS • Because it slopes up: o Shifts in AD affect output and employment • Long-‐run AS eqm P o Wages, prices, and expectations adjust AD o At potential GDP o Unemployment is at its natural rate Y N Using AD and AS Showing Long-‐run growth and inflation: LRAS LRAS LRAS But doesn’t P 3 explain the business cycle P 2 AD 2000 P 1 AD 1990 AD 1980 Y 1-‐-‐-‐Y2-‐-‐-‐Y3 ‐-‐-‐-‐ SRAS P 2 Short-‐run Ag Supply (SRAS) • Upward sloping curve • 1 to 2 year period P 1 • Increase in P causes increase in quantity of G&S supplied Y 2 Y 1 Economic Fluctuations • Caused by events that shift AS and/or AD curves • 4 steps to evaluate economic fluctuations 1) Determine whether event shifts AD or AS 2) Determine whether curve shifts left or right 3) Use AD-‐AS model to see how the shift Y and P in the short run 4) Use AD-‐AS model to see how economy moves from new SR eqm to new LR eqm SRAS 2 LRAS Economic Fluctuations (4 steps): Event-‐ oil prices rise SRAS 1 1. Increase costs, SRAS shifts 2. SRAS shift left P B 3. SR eqm at point B. 2 P 1 A a. P higher, Y lower, U higher Y 2 N Stagfication (from A to B): period of falling output and rising prices Accommodations and Adverse Shift in SRAS • Policy makers do nothing: o U = lower wages o SRAS shift right until LR eqm at A • Policy makers make policy o Increase AD and accommodate the AS shift (Keynes) o Y back to N, P permanently higher John Maynard Keynes: 1883-‐1996 • General Theory of Employment, Interest, and Money (1936) o Argues depression and recession can result from inadequate demand o Policy makers should shift AD Monetary Policy Monetary policy: setting of money supply by policy makers in the central bank o Expansionary: get $$ into economy o Contractionary: take $$ from economy Central bank: institution that oversees the banking system and regulates the money supply Federal Reserve (Fed): • Central bank of the US • Conduct monetary policy (auctions) Dual mandate: Price Stability and Maximum Employment • Supervise banks • Fiscal agent for U.S govt • Processes checks and electronic payments • Conduct economic research • Lender of Last Resort Federal Reserve System ( Fed Chair: Janet Yellen) • Board of governors-‐ on top o 7 members; in Washington DC • 12 Regional Fed Banks-‐ second o located around U.S • Federal open market Committee (FOMC) o Includes board of governors and presidents of some regional Fed banks o Decides monetary policy Circular Flow of Banking Deposits: Assets of public liabilities of banks Public OMO Fed Discount rate Banks Loans: Assets of banks liabilities of public Monetary Policy Tools: • Open-‐Market Operations/OMO: o Purchase and sale of U.S govt securities (T-‐bills) by the fed § Expansionary: purchase securities § Contractionary: sell securities • Fed loans: make loans to bank, increasing their reserves o Traditional method: adjust the Discount Rate § The interest rate on loans the Fed makes to banks o Federal Funds Rate: interest rate banks charge each other for loans; rate “set” by the Fed § Expansionary: lower rate § Contractionary: increase rate • Reserve Requirement: set by Fed o Regulations on the min amount of reserves banks must hold against deposits o Excess Reserve: amount beyond what bank must hold *All 3 tools create excess reserves for the banks. Allows them to create money through making loans Problems with Controlling Money Supply: • Households could hold their money as currency and not put in the banking system • If banks hold more reserves than required; few loans, lower money supply Bank Runs and Money Supply • 1929-‐33 bank runs and closings cause money supply to fall 28% • Fed deposits insurance, help prevent bank runs in the U.S A New Fed Response: • Quantitative easing (QE) o Nov. 2008 (QE1) o Buy more govt securities (LR) o Buy “toxic” assets The Velocity of Money • The number of transactions in which the average dollar is used • Notion: o P x Y= nominal GDP = (price level) x (real GDP) o M = money supply o V = Velocity • Velocity formula: o V = (P x Y)/(M) *Velocity is fairly stable over time The Quantity Equation of Money • Multiply both sides of viscosity formula by M: o M x V = P x Y 5 steps to the Quantity Equation of Money: 1. Quantity equation: M x V = P x Y 2. Change in M causes nominal GDP (P x Y) to change by the same % 3. Change in M doesn’t affect Y; money is neutral 4. P changes the same percentage as P x Y and M 5. Fast money supply growth causes rapid inflation. The quantity of money determines its value The Quantity Theory of money… • If real GDP is constant, then inflation = money growth rate • If real GDP is growing, then inflation < money growth rate • Bottom line: o Ecomonic growth increases the number of transactions o Some money growth is needed for the extra transactions o Excessive money growth causes inflation Government Budgets and Fiscal Policy Fiscal Policy • Setting the level of govt spending and taxation by govt policymakers o Expansionary or contractionary o Discretionary (deliberate manipulation) o Non-‐discretionary (automatic) Fiscal Policy and Aggregate Demand • Fiscal Policy (G) and taxation (T) by govt policymakers • Expansionary Fiscal Policy: o An increase in G and/or decrease in T o Shifts AD right • Contractionary Fiscal Policy: o A decrease in G and/or increase in T o Shifts AD left The Multiplier Effect • Additional shifts in AS the result when fiscal policy increases income and thus increases consumer spending Marginal Propensity to Consume • How big is the multiplier effect? o Depends on how consumers respond to additional income (spend, save?) • Marginal propensity to consume (MPC): o The fraction of extra income that households consume rather than save § So if MPC= .8 and income rises $100, C rises $80 § 80: C = MPC Y ( = change in) A Formula for the Multiplier Notion: G is the change in G Y and C are the ultimate changes in Y and C Y= C + I + G + NX -‐-‐-‐ identity Y = C + G -‐-‐-‐ I and NX don’t change because C= MPC Y Y = (1)/( G-‐-‐-‐-‐ solved for Y The multiplier • A bigger MPC means changes in Y cause bigger changes in C. • In turn, cause more changes in Y • Size of multiplier depends on MPC o If MPC= .5 multiplier = 2 o If MPC= .9 multiplier = 10 • The multiplier magnifies any autonomous change The Crowding-‐Out Effect AD AD1 2 3 • Govt borrowing and spending shifts AD to the right P 1 o Also raises r o Which reduces I $20bil o Which reduces AD • So the AD shift my be smaller than the multiplier would suggest • This is called the Crowding-‐out effect. Y 1 2 3 Y Fiscal Policy Ag Supply • Most economics believe: o SR effects of fiscal policy mainly work through AD • Fiscal policy might also effect AS o Ex: income tax cut, work more • People who believe this effect is large are called “supply-‐siders” The Case for Active Stabilization Policy • Keynes: o “Animal spirits”: pessimism and optimism among households and firms o Booms and recessions abroad o Stock market booms and crashes o “long-‐run” • If policymakers do nothing, the fluctuations: o Change AD, output, and employment o Are destabilizing to businesses, workers, and consumers The Case against Active Stabilization Policy • The Lag Argument: o Recognition lag o Legislative lag (takes an act of congress) o Implementation lag Automatic Stabilizers • Changes in fiscal policy that stimulates AD when the economy goes into recession, w/o policy makers having deliberate action • Examples: o Personal income tax: progressive tax-‐ tax rates rise with increasing income o Unemployment insurance o “Social safety net” programs Budget Deficits and Surpluses • Budget Surplus o Excess of tax revenue over govt spending o = T – G o = Public saving • Budget Deficit o Shortfall of tax revenue from govt spending o = G – T o = -‐ (public saving) • … financed by selling govt securities (treasury) The U.S Govt Debt • Govt debt = accumulated deficits • Debt to GDP ratio: o Measure of the govts indebtedness relative to its ability to raise tax revenue
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