Study Guide for test#2 - Macroeconomics
Study Guide for test#2 - Macroeconomics ECON 2105 080
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This 12 page Study Guide was uploaded by Gunawork on Sunday November 8, 2015. The Study Guide belongs to ECON 2105 080 at Georgia State University taught by Brian Hunt in Fall 2015. Since its upload, it has received 171 views. For similar materials see PRINCIPLES OF MACROECONOMICS in Economcs at Georgia State University.
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Date Created: 11/08/15
MacroEcon 2105 Study Guide for Test 2 Chapter 13, 15, 16, 17, 18 From the textbook… AD = C + I + G + NX LRAS = SRAS = AD Y = C + I + G + NX A budget deficit occurs when government outlays exceed revenue. It is also possible for the government to have a budget surplus, which occurs when revenue excee ds outlays. A debt is the total of all accumulated and unpaid deficits. Monetary policy is the use of the money supply to influence the economy. Monetary base = bank reserves + currency in circulation Monetary policy = bank deposits + currency Fiscal policy is the use of government spending and taxes to influence the economy. Expansionary fiscal policy occurs when the government increases spending or decreases taxes to stimulate the economy toward expansion. Expansionary monetary policy- occurs when a central bank acts to increase the money supply in an effort to stimulate the economy. (is monetary policy that increases aggregate demand) Contractionary fiscal policy occurs when the government decreases spending or increases taxes to slow economic expansion. Contractionary monetary policy- occurs when a central bank takes action that reduces the money supply in the economy. (is monetary policy that reduces aggregate demand) The use of fiscal policy to counteract business-cycle fluctuations is known as countercyclical fiscal policy. The marginal propensity to consume (MPC) is the portion of additional income that is spent on consumption: MPC = change in consumption / change in income The formula for this spending multiplier is: m^s = 1 / (1– MPC) Crowding-out occurs when private spending falls in response to increases in government spending. The Laffer Curve: Total income tax revenue depends on the level of income and the tax rate: income tax revenue = tax rate × income At low tax rates, increasing tax rates leads to increasing overall tax revenues. ↑ income tax revenue = ↑tax rate × income However, if tax rates get too high, increasing them further will decrease income. ↓ income tax revenue = ↑tax rate × ↓↓income Commodity money involves the use of an actual good in place of money. money supply (M) = currency + deposits required reserves = rr × deposits excess reserves = total reserves - required reserves The formula for the money multiplier is: m^m = 1 / rr TR = ER + AR E = excess ; A = actual Countercyclical Policy Tools //////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////// The aggregate demand curve Y = f (k, c) Y = C + I + G + NX Y = supply (AS) C and I and G = demand side (AD) Shifts of the aggregate demand curve The aggregate demand curve shifts because of: § changes in expectations § wealth § the stock of physical capital § government policies § fiscal policy § monetary policy The aggregate supply curve shows the relationship between the aggregate price level and the quantity of aggregate output in the economy. The Short-Run Aggregate Supply Curve § The short-run aggregate supply curve is upward-sloping because nominal wages are sticky in the short run: § a higher aggregate price level leads to higher profits and increased aggregate output in the short run. § The nominal wage is the dollar amount of the wage paid. § Sticky wages are nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labor shortages. W = Px (multiplied by) mp W=wages mp=productivity Shifts of the Short-Run Aggregate Supply Curve § Changes in § commodity prices § nominal wages § productivity § lead to changes in producers’ profits and shift the short-run aggregate supply curve. y= f (k, c) => Long-Run Aggregate Supply Curve § The long-run aggregate supply curve shows the relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages, were fully flexible. From the Short Run to the Long Run Details from the graphs above^ (a) Leftward shift of the short-run aggregate supply curve 1. Productivity (deceases) 2. Nominal wages (increases) 3. Causing commodity prices to-go-up (b) Rightward shift of the short-run aggregate supply curve 1. Nominal wages (decrease) 2. Commodity prices (decrease) 3. Productivity (increases) The AS–AD Model The AS-AD model uses the aggregate supply curve and the aggregate demand curve together to analyze economic fluctuations. Long-Run Macroeconomic Equilibrium § The economy is in long-run macroeconomic equilibrium when the point of short-run macroeconomic equilibrium is on the long-run aggregate supply curve. Recessionary Gap 1. Nominal wages decreases 2. Commodity/ input prices decreases 3. Productivity increases Inflationary Gap 1. Nominal wages increases 2. Commodity/ input increases 3. Productivity decreases Gap Recap • There is a recessionary gap when aggregate output is below potential output. • There is an inflationary gap when aggregate output is above potential output. • The output gap is the percentage difference between actual aggregate output and potential output. v Where’s the Deflation? § The AD–AS model says that either a negative demand shock or a positive supply shock should lead to a fall in the aggregate price level—that is, deflation. In fact, however, the United States hasn’t experienced an actual fall in the aggregate price level since 1949. Negative Supply Shocks • Negative supply shocks pose a policy dilemma: a policy that stabilizes aggregate output by increasing aggregate demand will lead to inflation, but a policy that stabilizes prices by reducing aggregate demand will deepen the output slump. Supply Shocks versus Demand Shocks in Practice § Recessions are mainly caused by demand shocks. But when a negative supply shock does happen, the resulting recession tends to be particularly severe. § There’s a reason the aftermath of a supply shock tends to be particularly severe for the economy: macroeconomic policy has a much harder time dealing with supply shocks than with demand shocks. Macroeconomic Policy § Economy is self-correcting in the long run. § Most economists think it takes a decade or longer!!! § John Maynard Keynes: “In the long run we are all dead.” § Stabilization policy is the use of government policy to reduce the severity of recessions and rein in excessively strong expansions. The Multiplier: An Informal Introduction § The marginal propensity to consume, or MPC, is the increase in consumer spending when disposable income rises by $1. § The marginal propensity to save, or MPS, is the increase in household savings when disposable income rises by $1. § Increase in investment spending = $100 billion § + Second-round increase in consumer spending = MPC × 2100 billion § + Third-round increase in consumer spending = MPC × $130 billion § + Fourth-round increase in consumer spending = MPC × $100 billion Total increase in real GDP = (1 + MPC + MPC2 + MPC3 + . . .) × $100 billion § So the $100 billion increase in investment spending sets off a chain reaction in the economy. The net result of this chain reaction is that a $100 billion increase in investment spending leads to a change in real GDP that is a multiple of the size of that initial change in spending. § How large is this multiple? The Multiplier: An Informal Introduction § An autonomous change in aggregate spending is an initial change in the desired level of spending by firms, households, or government at a given level of real GDP. § The multiplier is the ratio of the total change in real GDP caused by an autonomous change in aggregate spending to the size of that autonomous change. output = input income = wages + interest + rent + profits overall change in y Δy = Δwages + Δinterest + Δrent + Δprofits Assumptions 1. Taxes are = 0 = T 2. P, pi^2 = 0 3. r 4. No trade Income-Expenditure Equilibrium § The economy is in income–expenditure equilibrium when aggregate output, measured by real GDP, is equal to planned aggregate spending. § Income–expenditure equilibrium GDP is the level of real GDP at which real GDP equals planned aggregate spending. § When planned aggregate spending is larger than Y*, unplanned inventory investment is negative; there is an unanticipated reduction in inventories and firms increase production. § When planned aggregate spending is less than Y*, unplanned inventory investment is positive; there is an unanticipated increase in inventories and firms reduce production. The Keynesian cross is a diagram that identifies income–expenditure equilibrium as the point where a planned aggregate spending line crosses the 45-degree line. Consumer Spending § The consumption function is an equation showing how an individual household’s consumer spending varies with the household’s current disposable income. The Consumption Function - Deriving the Slope of the Consumption Function Aggregate Consumption Function § The aggregate consumption function is the relationship for the economy as a whole between aggregate current disposable income and aggregate consumer spending. Investment Spending § Planned investment spending is the investment spending that businesses plan to undertake during a given period. § It depends negatively on: Ø interest rate Ø existing production capacity § And positively on: Ø expected future real GDP. § According to the accelerator principle, a higher rate of growth in real GDP leads to higher planned investment spending. § According to the accelerator principle, a lower growth rate of real GDP leads to lower planned investment spending. Inventories and Unplanned Investment Spending § Inventories are stocks of goods held to satisfy future sales. § Inventory investment is the value of the change in total inventories held in the economy during a given period. § Unplanned inventory investment occurs when actual sales are more or less than businesses expected, leading to unplanned changes in inventories. § Actual investment spending is the sum of planned investment spending and unplanned inventory investment. Planned Aggregate Spending and GDP GDP = C + I YD = GDP C = A + MPC × YD Planned aggregate spending is the total amount of planned spending in the economy. AE = C + I Planned planned Government outlays = Government spending + Transfer payments • Difference between government spending and transfer payments? – Spending is when the government buys something in the marketplace – A transfer is when money is moved from one group to another Major Categories of National Government Spending • Mandatory outlays – Determined by ongoing programs such as Social Security and Medicare. – Cannot be altered during the budget process. – Altering requires long-run changes to existing laws. • Discretionary outlays – Can be altered when the annual budget is set. – Bridges, roads, payments to government workers, defense spending. The Laffer Curve • Outlays are government spending. • Revenues are gathered by taxes. • The debt is the cumulative sum of all yearly deficits. • Social Security and Medicare make up the largest portion of outlays, and this share has increased due to demographic changes. • The U.S. income tax system is progressive. • Fiscal policy is the use of government spending [G] and taxes to influence the economy. • Countercyclical fiscal policy has the goal of smoothing out cycles (ups and downs). • Increases in [G] and tax cuts must be paid for by borrowing. • Fiscal policy isn’t perfect because of lags, crowding out, and savings adjustments. • A higher MPC means a larger spending multiplier in the economy. • The Laffer curve shows the relationship between tax rates and tax revenues collected. § Commodity money is a good used as a medium of exchange that has other uses. § A commodity-backed money is a medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods. § Fiat money is a medium of exchange whose value derives entirely from its official status as a means of payment. § A monetary aggregate is an overall measure of the money supply. § Near-moneys are financial assets that can’t be directly used as a medium of exchange but can readily be converted into cash or checkable bank deposits. § • A T-account summarizes a bank’s financial position. § A bank run is a phenomenon in which many of a bank’s depositors try to withdraw their funds due to fears of a bank failure. • Deposit Insurance - guarantees that a bank’s depositors will be paid even if the bank can’t come up with the funds, up to a maximum amount per account. • Capital Requirements - regulators require that the owners of banks hold substantially more assets than the value of bank deposits. • Reserve Requirements - rules set by the Federal Reserve that determine the minimum reserve ratio for a bank. For example, in the United States, the minimum reserve ratio for checkable bank deposits is 10%. • The discount window is an arrangement in which the Federal Reserve stands ready to lend money to banks in trouble. • The monetary base is the sum of currency in circulation and bank reserves. • The money multiplier is the ratio of the money supply to the monetary base. • The federal funds market allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves. • The federal funds rate is the interest rate determined in the federal funds market. • The discount rate is the rate of interest the Fed charges on loans to banks. • Open-market operations by the Fed are the principal tool of monetary policy: the Fed can increase or reduce the monetary base by buying government debt from banks or selling government debt to banks. The Opportunity Cost of Holding Money § Short-term interest rates are the interest rates on financial assets that mature within six months or less. § Long-term interest rates are interest rates on financial assets that mature a number of years in the future. § According to the liquidity preference model of the interest rate, the interest rate is determined by the supply and demand for money. § The money supply curve shows how the nominal quantity of money supplied varies with the interest rate. § Inflation targeting occurs when the central bank sets an explicit target for the inflation rate and sets monetary policy in order to hit that target. § monetary neutrality: changes in the money supply have no real effect on the economy. So monetary policy is ineffectual in the long run. 1. The money demand curve arises from a trade-off between the opportunity cost of holding money and the liquidity that money provides. The opportunity cost of holding money depends on short-term interest rates, not long-term interest rates. Changes in the aggregate price level, real GDP, technology, and institutions shift the money demand curve. 2. According to the liquidity preference model of the interest rate, the interest rate is determined in the money market by the money demand curve and the money supply curve. The Federal Reserve can change the interest rate in the short run by shifting the money supply curve. In practice, the Fed uses open-market operations to achieve a target federal funds rate, which other short-term interest rates generally track. 3. Expansionary monetary policy reduces the interest rate by increasing the money supply. This increases investment spending and consumer spending, which in turn increases aggregate demand and real GDP in the short run. Contractionary monetary policy raises the interest rate by reducing the money supply. This reduces investment spending and consumer spending, which in turn reduces aggregate demand and real GDP in the short run. 4. The Federal Reserve and other central banks try to stabilize the economy, limiting fluctuations of actual output around potential output, while also keeping inflation low but positive. Under the Taylor rule for monetary policy, the target interest rate rises when there is inflation, or a positive output gap, or both; the target interest rate falls when inflation is low or negative, or when the output gap is negative, or both. Some central banks engage in inflation targeting, which is a forward-looking policy rule, whereas the Taylor rule is a backward-looking policy rule. In practice, the Fed appears to operate on a loosely defined version of the Taylor rule. Because monetary policy is subject to fewer implementation lags than fiscal policy, it is the preferred policy tool for stabilizing the economy. 5. In the long run, changes in the money supply affect the aggregate price level but not real GDP or the interest rate. Data show that the concept of monetary neutrality holds: changes in the money supply have no real effect on the economy in the long run.
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