Econ 313 Final study guide
Econ 313 Final study guide Econ 313
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This 16 page Study Guide was uploaded by Theo Friedman on Thursday June 4, 2015. The Study Guide belongs to Econ 313 at University of Oregon taught by John Voorheis in Spring 2015. Since its upload, it has received 213 views.
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Date Created: 06/04/15
Econ 313 Study guide Output 0 The most common measure of output is Real Gross Domestic Product 0 We also often are interested in Real GDP per person per capita Unemployment o the proportion of people in the labor force who don t have a job but are actively looking for one In a on Inflation measures how much prices are increasing over time quothyperinflationquot extremely high inflation rates GDP value of final goods and services produced in the economy GDP is also equivalent to the total income wages profits etc in the economy Value added is simply the final good sales price less the cost of intermediate goods Y C I G X IM GDP is the sum of Consumption Investment Government Spending and net exports C consumption Investment Ggovt spending XIM exports imports Y Real GDP constant base year prices better measure Y Nominal Price adjusts each year Employment Labor force Working Pop Population P Labor force L unemployes U EmployedE NILf Not in labor force UR Unemployment rate LFPR Labor force participation rate P LNILF L UE URUL LFPR LP discouraged workersunemployed people dropping out of the labor force The GDP deflator is the ratio of nominal to real GDP Pt Yt Yt The CPI is the price of the quotCPI basketquot in current dollars Inflation is the percent change in these price indices 1T P P P P last year Okun s law I the relationship between output growth and the change in the unemployment rate is negative linear and has a slope of about O5 Phillips curve that there is a tradeoff between unemployment and inflation at least in the short run Together these relations point to the central lesson of economics we want high growth low inflation and low unemployment but it might be impossible to accomplish all three Investment 0 Residential investment is all purchases of new homes and apartments by households l o Nonresidential investment is all purchases of plants machinery equipment software and intellectual property by firms l 0 Inventory investment is all final goods and services produced by firms in one year but kept in inventory for future years Assumptions 0 All firms produce a single good which is used for investment and consumption l 0 Firms are pricetakers and are willing to supply any amount of the good at the market price p l The price of goods is fixed in the short run I The economy is closed so that X IM 0 Z E C l G is demand equation Consumption The most important determinant of consumption is disposable income YD C Co C1 YD c1 is the marginal propensity to consume MPC cO autonomous consumption the portion of consumption which doesn t vary with income 0 C CD c1 Y T with taxes included Equilibriums Y OutputGDP 1 1 c1 c0 c1T l G o multiplierx term autonomous spendingintercept term 0 know how to interpret changes 0 Production is determined by demand production is equal to income and demand is determined by income 0 The multiplier is the central mechanism by which changes spending affect output Investment amp savings 0 Private savings is S YD C MOney demand 0 people can hold their wealth either in money or in bonds 0 Money is a liquid asset that can be used to buy goods and services 0 Money is composed of l o currency which is provided by the government o checkable deposits which are provided by the financial sector 0 Bonds are illiquid assets that provide some return but cannot be used for transactions Demand for 0 lfthe interest rate is higher households might be more likely to hold bonds 0 How responsive the demand for money is to the interest rate is summarized by the liquidity function L i We assume the level of transactions is equal to total nominal income We can then summarize the relationship between the demand for money Md and the interest rate as Md YL i L i represents a negative relationship between interest rates and money demand As interest rates rise households hold more bonds and less money The demand for money increases with aggregate income supply and equilibrium 0 In equilibrium the supply of money equals money demand so that M YL i Market operations 0 n expansionary monetary policy it buys bonds from banks and creates new money 0 n contractionary monetary policy it sells bonds and destroys the money used to purchase them Bond Prices 0 interest rates also called bond yields can be calculated based on prices 0 Consider a bond that pays 100 for sure in 1 year If you were to pay PB for the bond today then the rate of return is i 100 PB PB o if we have an interest rate we can figure the bond price from it PB 100 1 i 0 Buy bonds and decrease rates sell bond and increase rate 0 financial intermediaries pool deposits from a large number of consumers and buy assets make loans I Not all financial intermediaries are banks eg mutual funds Banks assets consist of loans and bonds We assume that banks also hold some liquid assets as reserves 0 central bank money household currency and reserves of banks Reserves 0 e amount of cash that depositors withdraw might not be equal to the amount that depositors deposit 0 required reserve ratios in order to prevent bank runs 0 Money supply is now currency held by households and reserves held by banks 0 Money demand is now the demand for reserves plus the demand for currency Demand for currency o CUdch Dd1cMd Demand for reserves 0 R d e 1 c Md 9 required reserves ratio Demand for central bank o Hdc91CYLi o H s H d gt H c e 1 c YL i equilibrium Money Multiplier o Equilibrium 1 ce1 c H YL i 0 money multiplier can be thought of as the change in money supply due to successive purchases of bonds by banks ISLM model 0 I the IS relation which describes goods market equilibrium 0 LM relation which describes money market equilibrium 0 describes how the money market and the goods market interact IS Goods Market Equilibrium o loosen this assumption by allowing investment to depend on both output and the interest rate 0 assume that Investment now depends on two factors the level of sales ie output and the interest rate YCY TIYiG As before increases in output will increase investment and consumption and hence demand 0 increases in the interest rate will lead to decreased investment which will shift the goods market equilibrium curve downward Any change to autonomous spending will result in a shift of the IS Curve Any change in autonomous spending that would shift the goods market equilibrium down will shift the IS curve back LM relation 0 M P YL i c Any change in interest rates or income is exhibited as a movement along the LM curve 0 a change in any other variable will shift the LM curve Together 0 the IS relation which tells us how interest rates affect output IN the 0 LM relation which tells us how output affects interest rates 0 overall general equilibrium in the economy occurs goods market and the money market are in equilibrium simultaneously 0 Any point on the IS curve is an equilibrium in the goods market Any point on the LM curve is an equilibrium in the money market Fiscal Policy c There are two policies that policymakers can use in the ISLM model I o policymakers can change taxes and spending fiscal policy I Or they can change the money supply monetary policy both new equilibrium interest rate and equilibrium output are lower after fiscal contraction Reducing the deficit will result in both lower output and lower interest rates Taxes do not affect the money market equilibrium directly but they do affect the goods market through consumption Monetary policy We refer to an increase in the money supply as expansionary monetary policy or a monetary expansion A decrease in money supply is contractionary monetary policy or monetary tightening an increase in the money supply The equilibrium output in the lS LM model is higher and equilibrium interest rates are lower Disposable income increases so consumption and investment increases Since the interest rate falls and output is higher investment increases as well Policy mix monetary amp fiscal authorities coordinate simultaneously using fiscal and monetary policy best way for deficit reduction central bank expand supply fiscal reduce deficit Liquidity trap we have been assuming that the equilibrium interest rate is strictly positive Nearzero interest rates and sluggish growth are rare led to a large spike in the risk premium quotriskyquot bonds lead to an increase in borrowing costs for firms leading to to decrease in investment also led to a decrease in consumer confidence leading to consumption decrease At an interest rate of zero however households are indifferentbetween purchasing bonds and holding money since both have the same return Graphically the money demand curve becomes horizontal at an interest rate of zero This is the liquidity trap the central bank can increase liquid assets liquidity only so far before interest rates run into the ZLB and the Central bank loses its ability to increase output fiscal policy is still effective at the zero lower bound Additionally central banks may be able to engage in quotunconventional monetary policyquot Midterm 2 Econ 313 Labor market 0 The unemployment rate is U LF 0 LFPR is UEP and employment 0 population ratio is EP The household survey is designed to measure the unemployment rate The Establishment survey is designed to track employment the number ofjobs lf fewer hires the chance of an unemployed worker finding a job falls lf firms layoff workers the employed experience a higher risk of losing theirjobs Wages We now consider how wages are determined This could be done in a number of different ways 0 l Collective Bargaining is common for unionized jobs 0 l Employers will often post wages they set the wage workers can take it or leave it o I If workers have scarce skills they will often be able to negotiate for higher wages The bargaining power of a worker depends on How costly it is for the rm to replace a worker Required job skills How difficult it is for a worker to nd another job Labor market conditions W Pe F u z 39339 W denotes aggregate nominal wage Pe denotes the expected price level u denotes the unemployment rate inversely related to wages 2 denotes all other variables that are positively correlated with wages We can use this to establish a relationship between real wages and the markup over marginal cost called the pricesetting relation WP11m 0 At the natural rate of unemployment we get the natural level of employment 0 Nn L1 nun Yn L1 un o Rearranging this equation one can show that un 1 nYnL l l PS 3 Real wage WIP 3 A A l PS I W3 u u Ulnemplloymenlt rate u Aggr Supply 0 aggregate supply relation captures the effects of output on the price level 0 P Pe1 mF 1YL Z n o This gives us a relation between the price level P the expected price level Pe and output 0 the price level also depends on the markup m the size of the labor force L and the catchall 2 which includes eg unemployment benets AS A8 for expected price level Pa 7 Tl l Tl E A Price level P I I Yr Output Y Aggr Demand 0 The aggregate demand relation captures the effect of the pricelevel on equilibrium output in the goods and money markets 0 YYMPGT We can think of two equilibria then a short run equilibrium where Pe is fixed and a medium run equilibria where Pe is flexible short run Pe isn39t equal to the true price Price level P Output Y Medium run wage setters revise expectations 1amp3quot AS39 Price level P p AFT PE i l v w v Output Y In the short run 0 l Output can be above or below the natural level of output 0 l Changes in any of the variables that enter the AS or AD relation lead to changes in output and to changes in the price level In the medium run 0 l Output returns to the natural level of output 0 I This adjustment works through changes in the price level 0 I When output is above the natural level of output the price level increases which decreases demand and output Monetary policy 0 In the short run expansionary monetary policy decreases interest ratesand increases output It also slightly increases prices 0 I As time goes on however wage setters adjust their price expectationslf monetary policy pushed output past its natural rate then the AS curve will shift up as price expectations catch up with real prices 0 I In the medium run output cannot be pushed above its natural rate lnfact the only medium run effect is an increase in prices Deficit reduction EIHZI Price level P 39 rI urlput rill L i i39 it Interest rate i urlputg if Philpis Curve Let 1T denote the inflation rate and 1Te denote the expected inflationrate Then with some annoying algebra one can show that o 1T1Temzdu Substituting 1Te 0 into Equation 2 yields 0 1Tt m z dUt wageprice spiral Low unemployment leads to higher nominal wages This leads firms to increase prices and a higher price level An increase in the price level leads workers to ask for higher wages nexttime wages are set The higher nominal wage leads to further increases in the price leveletc ThPONT that before about 1960inflation was more likely tooscillate around 0 After 1960 inflation is bothconsistently positive and morepersistent 1Tt 91Tt 1 m z out If 9 0 then we just have the original Phillips Curve lf 0 lt e lt 1 then inflation depends on last periods inflation but on aless than one for one basis For 9 1 As the value of 9 increased fromO to 1 the original Phillips curverelationship disappeared This relation is often called the expectations augmented Phillips curve 1Tt 39th1 dUt Un c When unemployment is above its natural rate inflation is decreasingwhen unemployment is below its natural rate inflation is increasing At Ut Un inflation isn t changing Hence another name for the natural rate of unemployment is oftenthe NAIRU the nonaccelerating inflation rate of unemployment since 1970 in the US the average rateof unemployment required to keep inflation constant has been equalto 6 Neutrality of Money lf unemployment is at it s natural level then the aggregate demandrelation becomes Yn YMP G T 0 Let gM be the growth rate of money Assume that 1T the growth rate of prices inflation is above zero Then AM P O gt 1T gM o In the medium run the rate of inflation is determined by the rate of money growth Nothing about the Phillips curve relationship we ve studied requires itto be constant over time nor across different countries he natural rate of unemployment depends on factors that affectwages 2 firms markups over marginal cost m and the response of inflation to unemploymentThere s no reason these are the same across countries Lucas Critique estimates of relationships from past data may notaccurately predict future outcomes if people s expectations change Wage lndexation a provision thatautomatically adjusts wages for inflation o This leads to a stronger response of inflation to unemployment the PhillipsCurve relation breaks downwhen there is deflation Expectations Nominla vs Interest rate real interest rates 0 Real interest rates are expressed in terms of units of goods 0 if we borrow 1 unit of goods at a real interest rate ofr 005 we agree to pay back 1 r 1 05 units of goods in the future 0 nominal interest rates are real interest rates adjust for expected ination 1 r1 i 1 et1 R i 1T t1 investment will depend on the real interest rate ri we The interest rate that central banks can affect is the nominal interest ratel The interest rate that affects output is the real interest ratel So the effectiveness of monetary policy depends on how changes in the nominal interest rate translate into changes in the real interest rate Discounted present values 0 the value ofnunits of goods next year in terms of today39sconsumption is n1r o the present value of consuming n units in two periods 11rt1rt1 n o The expected discounted present value of a flow of consumption is Vzt11 rt zet1 11 rt 1 ret1 zet2 households care only about consumption ofgoodsso they discount by the real interest rate VYeLTeL 11 ret YetTet 1 1 ret1 ret1 Yet2 Tet2 assume that consumption depends on both current disposable income as well as the discounted present value of future disposable income CCYt Tt VYeLTeL Econ 313 post midterm 2 Long run growth 0 Our measure of the standard of living in a country is then output per person not total output Across counties Exchange rates vary a lot over time and this variation does not re exchanges in the standard of living in a country 0 Wide exchange rate swings are quite common 0 Exchange rates only tell us about the relative price of tradable goods Cost of living the price of tradable and nontradable goods and services varies across countries We can do this by calculating GDP using a common set of prices for all countries including nontradable goods purchasing power parity Convergence the further away from the quotsteady statequot a country is the faster its growth rates 0 Its hard to make general statements but Asian countries exhibited convergence amp not African countries 0 As China begins to catch up to richer countries like the US and the EU it will almost surely see its growth rates decline Solow Model two main determinants of growth 1 capital accumulation 2 technological progress aggregate production function Y FKN Capital is the total amount of physical plants machinery and software used in production 0 Labor is the number of workers employed by rms Assume constant returns to scale CRTS if we double both the number of workers and the amount of capital in the economy output will double diminishing returns to capital Each additional unit of capital we add to the economy produces a smaller increase in output production function is concave YN is output per worker or average output KN is the capitallabor ratio Growth in Solow Model Increases in capital per worker capital accumulation Improvements in the state of technology technological progress 0 Capital accumulation by itself cannot sustain growth permanently decreeing returns Assumption 1 size of the population is constant and all people work so that N is constant Assumption 2 There is no technological progress Assumption 3 The economy is closed Assumption 4 Public saving is equal to zero Assumption 5 Private saving is proportional to income absent any investment capital depreciates wears out at a xed rate 6 Kt1N KtN sf KtN 6 KtN The change in capital per worker from year to year depends on 0 Investment per worker in the previous period sf KtN Deprecation per worker in the previous period 6KtN State which output per worker amp capital per worker are not changing steady state the economy 0 YN f KIN How does the saving rate affect the growth rate of output per worker 1 The saving rate has no effect the long run growth rate of output per worker which is zero 2 The saving rate determines the steady state level of output per worker in the long run 3 increase in the saving rate leads to higher growth of output per worker for a time not forever Saving Rate amp consumption Governments can affect the saving rate through policy 0 directly Public saving is affected by government spending adjustments indirectly Private saving is affected by changes in taxes What should the saving rate be o If the saving rate is zero and always has been there is no capital accumulation and hence no output This in turn implies that consumption is zero o If the saving rate is one people save all their income capital accumulation and hence output is very high but consumption is zero 0 There must be some value of the saving rate between zero and one that maximizes the steadystate level of consumption this is golden rule savings rate Technology 0 lead to more output for a given quantity of inputs 0 lead to better products 0 lead to new products 0 lead to a larger variety of product State of Technology how much output can be produced from given capital and labor at any time 0 AN is called effective labor or sometimes quoteffective workerquot When add in technology interested in output per effective worker capital per effective worker YAN f KAN Including assumption that public saving is zero YAN sf KAN Let 6 be the depreciation rate of capital gA be the rate of technological progress gN be the population growth rate Assume the population is composed of workers population growth rate same as the growth rate of the labor force the growth rate of effective labor is gA gN capital accumulation per effective worker t are time subscripts Ktl Atl Ntl Kt At Nt sf Kt At Nt 6 ga gn Kt At Nt graphically this parallels the Solow growth model graph from the previous chapter 0 in a steady state output per effective worker does not grow at all 0 output per worker grows at rate gA Because output capital amp effective labor grow at 9A gN in steady state state of balanced growth Two scenarios in which a country might see fast growth rates 0 country might be experiencing steady state growth in output per worker high technology growth 0 Country has temporarily fast growth due to capital accumulation transitions steady states If growth of output in excess tech growth the economy is in transition between steady states If the growth of output growth of technology we are on a balanced growth path Growth rate of technology gA 11 oz gY cng 1 oz gN Technological Progress Output and Unemployment in the Short Run 0 No longer assume that the entire population works 0 the AS and AD relations now depend on technology 0 An increase in A unambiguously shifts the AS curve down 0 If tech creates a major invention might lead increase consumer con dence shift AD right o If tech makes inventions more ef cient might decrease consumer sentiment shift AD left 0 Output growth tends to exceed productivity growth expect technology increases employment Medium Run Converge back to the natural rate of unemployment Technological unemployment argues that technological progress leads to increases in unemployment A more plausible argument of technological unemployment is that unusually high technological progress is associated with higher natural rate of unemployment unusually low technological progress is associated with a lower natural rate of unemployed AFuzA1m gtFuz11m The natural rate of unemployment is independent of technology Implications 1 The natural rate of unemployment should not depend on the level of productivity 2 The natural rate of unemployment should not depend on the rate of productivity growth 0 In short run there is no relation between movements in productivity growth amp unemployment In the medium run if there is a relation it is an inverse relation Fears of tech unemployment come from structural change of economy due to tech progress 0 Structural change may mean that some workers skills will no longer be in demand Wage Inequality Over the last 25 years the US has experienced a large increase in wage Much of this increase in inequality may be due technological change Skillbiased tech change leads to larger returns to skill new tech requires educated workers 0 There39s no reason to believe that the trends in relative demand are going to continue forever the top share 1 is cyclical it goes down in recessions We see increasing inequality from the 197039s onward after the mid199039s inequality seems to be increasing much more slowly Since 1990 some states have become more unequal others like New York are actually more equal Inequality might lead to lower growth rates over time Inequality might lead to increased indebtedness making nancial crises more likely Inequality can lead to political polarization
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