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Econ 201 Exam 4 Study Guide

by: Ekene Tharpe

Econ 201 Exam 4 Study Guide ECON 201

Ekene Tharpe

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Covers all of week 13-16 material. Covers all aspects of unemployment, aggregated demand and supply, monetary policy, and government budgets and fiscal policy.
Intro Economics: Survey Course
Donna Bueckman
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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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