Exam Three Complete Study Guide
Exam Three Complete Study Guide ECON 2305 - 001
Popular in PRINCIPLES OF MACROECONOMICS
Popular in Economcs
This 18 page Study Guide was uploaded by DulyNoted on Monday November 9, 2015. The Study Guide belongs to ECON 2305 - 001 at University of Texas at Arlington taught by Ronnie W Liggett in Summer 2015. Since its upload, it has received 294 views. For similar materials see PRINCIPLES OF MACROECONOMICS in Economcs at University of Texas at Arlington.
Reviews for Exam Three Complete Study Guide
Report this Material
What is Karma?
Karma is the currency of StudySoup.
You can buy or earn more Karma at anytime and redeem it for class notes, study guides, flashcards, and more!
Date Created: 11/09/15
ECON 2305 Principles of Macroeconomics Exam 3 Study Guide Chapter 11: Classical & Keynesian Macro Analyses The Classical Method Assumptions: - Pure competition exists - Wages and Prices are flexible (adjustable up and down) - People are motivated by self-interest and cannot be fooled by money illusions Consequences of Assumptions - The role of government in the economy is minimal - If pure competition prevails, all prices/wages are flexible - If people are self-interested and are do not experience money illusions, then problems in the macro economy will be temporary and the market will correct itself. *The government cannot solve everything because their decisions can’t take everything into consideration Say’s Law: Producing goods and services generates the means and the willingness to purchase other goods and services. REMEMBER: “Supply creates its own demand.” Desired Expenditure = Actual Expenditure EQUATING DESIRED SAVING AND DESIRED INVESTMENT IN CLASSICAL METHOD *The leakage of savings is match by the injection of business investments via credit market. Aggregate Demand = Downward Sloping Aggrade Supply = Upward sloping Keynes Theory Short-Run Aggregate Supply Curve: - Horizontal - Excessive unemployment and unused capacity in the economy. Keynes assumed that prices will not fall when the aggregate demand falls and that there is excess capacity, so prices will not rise when AD increases. Thus SRAS Curve is simply a horizontal line at a given price level. Short-Run Aggregate Supply Curve: relationship between total planned economy wide production and the price level in the short run. Represent relationship between PRICE LEVEL & REAL GDP *If price adjust incompletely in the first run, curve is possibly sloped. EXPLAING THE SRAS UPWARD SLOPE (REAL GDP RISES AND PRICE LEVEL INCREASES) 1. Firm using existing workers more intensively 2. Existing capital equipment is used more intensively 3. Wage rates are held constant, higher price level leads to increased profits from additional production, which induces firms to hire more workers. * Employment rate falls Changes Factors of Production that Shift in BOTH Shot & Long Run Aggregate Supply: Labor Capital Technology Shifts in Only SRAS: *Short lived & Do not impact LRAS - Changes in production input prices - Caused by external Events - Not expected to last forever Aggregate Demand Shock: causes AD curve to shift inward or outward Aggregate Supply Shock: causes the SRAS curve to shift inward or outward Recessionary Gap: whenever equilibrium real GDP per year is less than full employment real GDP as shown by position of the LRAS curve. (Leftward Shift) Inflationary Gap: whenever equilibrium real GDP per year is greater than full-employment real GDP as shown by position of the LRAS (Rightward Shift) Stronger Dollar Affects: - Increase in SRAS - Cheaper input costs (Raw Materials and Foreign Labor) - Decrease in AS -More Imports -Fewer Exports - Price level definitely falls - Deflation On Aggregate Supply (a): - Curve shifts outward to the right - Equilibrium real GDP rises - Price level declines - Firms produce more final goods services On Aggregate Demand (b): - Make imported goods less expensive - Fewer exports/More Imports - Lower net exports (= Exports - Imports) - Curve shifts inward to left - Equilibrium real GDP AND price levels fall - Unemployment Increases TWO Types of Short-Run Inflation Demand Pull: caused by increase in aggregate demand not matched by increase in aggregate supply The commonest causes: Earnings rising above factor productivity. Cheaper credit, following a reduction in interest rates. Excessive public sector borrowing. A housing boom creating equity withdrawal and a positive wealth effect. Changes in the savings ratio. Cost Push: caused by increase in short-run aggregate supply Results in higher prices and higher unemployment The commonest causes are: - Oil price shocks, caused by wars or decisions by OPEC to restrict output. - Increases in farm prices or general food prices, following a series of poor harvests. - Rapidly rising wage costs. - A fall in the exchange rate, which increases the price of all imports. - Imported cost push inflation as a result of inflation in other parts of the world. Supply Side Economics: 1. Energy 2. Inflationary mentality 3. AG short falls 4. Union wages 1970s – Gas Shortage OPEC A cartel that controls the energy market (cut supply to up the price) Cartel = independent producers and suppliers who coordinate pricing and output decisions in order to maximize profit * Illegal in the US Typically fail due to: 1. Disagreements 2. Cheating 3. Profits encourage entry (jacking up prices) Why has OPEC survived? Power base split into small countries What’s the impact of petroleum prices on normal consumption? Everything is affected via a price ripple effect resulting in supply side shock (felt by every aspect of the economy) What does this look like with AD/AS analysis? 1. Most workers in the nation’s economy are union members, and unions have successfully negotiated large wage boosts. SHIFT SUPPLY LEFT At the same time, economic conditions worsen abroad, including real GDP and disposable income in other nations of the world. SHIFT DEMAND LEFT FINAL = (“E”) 2. A major hurricane has cause short term halts in production at many firms and created major bottleneck in the distribution of goods and services that have been produced prior to the storm SHIFT SUPPLY RIGHT At the same time, the nation’s central bank has significantly pushed up the rate of growth of the nation’s money supply SHIFT DEMAND LEFTWARD FINAL = (“C”) Chapter 12: Consumption, Real GDP, and the Multiplier Simplified Assumptions of Keynesian Model 1. Businesses pay no indirect taxes (ex: sales tax) 2. Businesses distribute all profits to shareholders 3. No Depreciation. Gross Private Domestic Investment = Net Investments 4. The economy is closed- No foreign trade Disposable Income: - You can either SAVE or CONSUME a dollar of disposable income - Disposable Income = Consumption + Savings - An accounting identity, holds truth at every moment in time Saving - An action - Occurs at a particular rate (rate is a flow) - Expressed: Per Unit of Time (typically a year) - Whatever is not consumed of disposable income - Savings = disposable income – consumption Savings - Stock concept - Measured at certain point/instant in time - Result of your past saving - An accumulation resulting from prior acts Investment - Flow concept - Expenditures of capital goods (machines/buildings) - Expected to yield a future stream of income - Supply of saving determined by rate of interest (higher interest rates = more savings/less consumption) Life Cycle Theory of Consumption - Most realistic/detailed - Considers consumptions and savings over a life span (current and future) - When higher income is anticipated, individual consumes more and saves less now - When income drop in anticipated, individual consumes less and saves more Permanent Income Hypothesis - Permanent income = expected average lifetime income - People only increase consumption flow if anticipated average lifetime income rise (If rise is temporary without increase in lifetime income, the response is to save the extra income) - Consumption is unchanged by temporary increases Consumption Function: Keynes argued that real consumption and saving decisions depend primarily on a household’s CURRENT real disposable income. Real Consumption and Saving Real Disposable Income per Year (Yd) Planned Real Consumption per Year (C) Planned Real Savings per Year (S=Yd-C) Average Propensity to Consume (APC=C/Yd) Average Propensity to Save (APS=S/Yd) Marginal Propensity to Consume (MPC=ΔC/ΔYd) Marginal Propensity to Save (MPS=ΔS/ΔYd) *Δ= “Change in” Dissaving: spending exceeds income by borrowing/use up existing assets (Negative saving/debt) CONSUMPTION FUNCTION (CF) (Upper Chart) - 45 degree line is where Planned Real Expenditures = REAL GDP per year - Every point on 45 degree line, vertical line drawn to the income axis is the same distance from the original horizontal line drawn to consumption axis. - Break Even Point: PRC=RSI (F) (no savings) * Consumption function intersects 45 degree - Vertical distance between 45 degree line and the CF (in red) measures the rate of: Real savings (to the right of Break Even Point) Dissaving (to the left of Break Even Point) - Autonomous Consumption is independent of real disposable income. If it changes it shifts CF (Autonomous = existing independently) SAVINGS FUNCTION (SF) (Lower Chart) - Mathematically, SF is the complement of CF because CF + SF =Disposable Income -Plots Real Disposable Income (Yd) and (S) Average Propensity to Consume = Real Consumption/Real Disposable Income OR (APC=C/Yd) - For any given level of income, the proportion of total real disposable income that is consumed. Average Propensity to Save = Real Saving/Real Disposable Income OR (APS=S/Yd) - For any given level of income, the proportion of total real disposable income that is saved. ACP + APS = 1 (100% of total income) Marginal Propensity to Consume = Change in Real Consumption/ Change in Real Disposable Income OR (MPC=ΔC/ΔYd) - EX: MPC of .8 tell us an additional $100 in take home pay will lead to an additional $80 consumed. Marginal Propensity to Save = Change in Real Savings/Change in Real Disposable Income OR (MPS=ΔS/ΔYd) - EX: MPS of .2 tells us that out of an additional $100 in take home pay, $20 will be saved. MPC + MPS = 1 (100% of the change in income) Determinants of Investment - Planned real investment is determined by the rate of interest (Inverse Relationship) - Planned Investment schedule shows the relationship between real investment and the interest rate (Downward slope) -Shift in non-interest-rate determinant of planned investment will cause a shift in investment function Non-interest-rate Determinants of Planned Investment: - Expectations - Innovations/ technological changes - Business taxes Determining Equilibrium Real GDP Autonomous: - Consumption function (CF) has an autonomous part that is independent of level of real GDP - Autonomous = with respect to real GDP and unaffected by level of GDP (horizontal line) - Equilibrium Level of real GDP (where planned savings = planned investments) - Where CF intersects 45-degree line C=Y -Unplanned Inventory Increase: when planned saving exceeds planned investment - Real GDP will fall as producers cut production of goods/services -Unplanned inventory Decrease: when planned savings is less than planned investments - Real GDP will rise as producers increase production of goods and services C + I =Y (Sum of consumption spending and investment spending = real GDP ) Spending = output (45 degree line) “Equilibrium situation” GDP = C + G + I + Nw NDP NI PI DI = C C= a + MPC X Yd (C= a + MPC X DI ) C = 50 + .8Yd Y= 50 + .8Y 2Y = 50 Y = 25 C = 50 + .8Yd I = 50 C + I = 50 + .8Yd + 50 Y = 100 + .8Y 2Y = 100 Y = 50 Multiplier = 1/ (1-MPS) | Multiplier = 1/PMS Initial Change in Spending X Multiplier = Total Change in Equilibrium Output C = 100 + .75Yd I = 75 C+ I = 100 + .75Yd + 100 75 Y = 200 175 + .75 .25Y = 175 -> Y = 700 = C + I Y = 100 + .75Y .25Y = 100 Y=400 C+1 = 700 C = 400 Chapter 13: Fiscal Policy Fiscal Policy: The discretionary changing of government expenditures or taxes to achieve national economic goals such as higher employment with price stability. Contractionary = Decrease Government Spending = Increase Taxes Expansionary = Increase Government spending = Decrease Taxes Recognition Time Lag: The time required to gather information about the current state of the economy - Identify a problem - Gather data Action Time Lag: Time between recognizing economic problem and implementing policy to solve it - implementing policy… - Long, long time! - Requires Congressional approval Effect Time Lag: The time that elapses between the implementation of a policy and the result of it Political - Political Business Cycle: Concept that politicians manipulate an economy (usually by increasing or decreasing money supply) to achieve personal ends, especially during an election period. - Government spending driven by politics - President and Congress - Council of Economic Advisers: (CEA) is an agency within the Executive Office of the President that advises the President of the United States on economic policy. “Lower rates of taxation will stimulate economic activity and so raise the levels of personal and corporate income as to yield within a few year an increased- not a reduced- flow of revenues to the federal government.” – John F. Kennedy 1963, Budget Message to Congress Crowding Out: Tendency of Expansionary Fiscal policy to cause a decrease in planned investments or planned consumption in the private sector. (Decrease normally results from rise in interest rates) - Government seeks funds - Increased demand for loanable funds - May increase Interest rates - Higher I = less borrowing - (But, has it really happened???) - However, when G takes the funds, where do they come from? US! Crowing Out – The push for loanable funds Gov. Other Issues with Fiscal Policy - How do you pay for G? - Do you increase Taxes? - Do you borrow? - What happens in you borrow? CROWDING OUT Automatic Spending - Tax System - Progressive nature - Unemployment Compensation - Transfer Payment - One Example: SNAP - Supplemental Nutrition Assistance Program - “America’s fastest growing social welfare program”- Per Cato Institute - 2000 – 17 million participants @ $18 Billion a year - Today – 48 Million Participants @ $78 Billion a year - Doubled since 2009 - Form of fiscal policy P.S. ---- Why the Tax Rebates Fizzled (see text) - Taxpayers paid off debt - Saves rebates to pay off future taxes - Temporary tax cuts --- not as effective Comparison: Government Spending v. Tax Cuts Which is stronger? - Per text – Tax Cuts - Multiplier effect… PROBLEMS DONE IN CLASS Assume the multiplier in a country is equal to 10 and that autonomous real consumption spending is $5T If current real GDP is $20T, the current value of real consumption spending is $___T. What is MPC? Multiplier is 10, there for MPS = .9 (1/10=.9) Think about: C= a + mpc DI 5 + .9(20) = ? Answer: $23T What is Autonomous Spending? What Is MPC? Whichis True ? 1. 5 = C at an income level of 6 False – where DI = 6, C = 6 2. At an income level of 0, there is dissaving equal to 3. True 3. C = 6 + .5DI False – autonomous spending is 3 4. C = 3 + .5DI True Which will cause a planned investment shift rightward: - An increase in expected profits – YES - An improvement in technology – YES - A decrease in business taxation – YES - A decrease in interest rate – NO MPC = (10,000-2,500) / (12,000-2,000) = .75 MPS = (2,000 –(-500)) / (12,000-2,000) = .25 If the economy is experiencing an inflationary gap, which fiscal policies can congress enact to attempt to correct it? A. Decrease Money Supply and Increase Taxes B. Increase Government spending and Decrease Taxes C. Increase interest Rates and Decrease Money Supply D. Decrease Government Spending and Increase Taxes C = 50 + .8(Y-T) I = 60 G =70 T = 30 What Is Equilibrium Output? C + I + G = 50 + .8(Y-30) + 60 + 70 Y = 180 +.8Y – 24 .2Y = 156* Y = 780 C = 50 + .8(Y-T) I = 60 G = 85 T = 45 What Is Equilibrium Output? C + I + G = 50 + .8(Y-45) + 60 + 85 Y = 195 +.8Y – 36 .2Y = 159* Y = 795 *Multiplier = 1/.20 = 5 If the MPC is .8 and taxes are increased by 30, what is the expected overall impact on the equilibrium output in the economy? A. -120 B. -24 C. 240 D. 120 If initial equilibrium real GDP is $400 billion, MPC = .9 and autonomous investment increases $40 billion, equilibrium real GDP will be A. $ 600B B. $ 360B C. $ 800B D. $ 400B ***HELPFUL HINT: When the MPC is .9, the multiplier is 10 When the MPC is .8, the multiplier is 5 When the MPC is .75, the multiplier is 4 When the MPC is .6, the multiplier is 2.5 When the MPC is .5, the multiplier is 2 Chapter 15: Money, Banking, and Central Banking Money: anything readily acceptable as payment for goods and services or in repayment of debt “Anything” – see textbook Examples of things that have been use as money from textbook: *Prison $ = cigarettes Functions of Money - Medium of exchange (any item seller will accept as payment) - Unit of accounting (a measure by which prices are expressed; a central property of money) - Store of value (the ability to hold value over time; necessary property of money) - Standard of deferred payment (a property of an item that makes it desirable for use as means of settling debts maturing in the future; an essential property of money) Evolution of Payment - Barter - Universal acceptance - Currency - Checking - Electronic What gives $ Value? - Widespread acceptance - Confidence - No intrinsic value Financial Intermediaries - Bank - Credit Union - Savings & Loans - Insurance Companies WHAT DO THEY DO? – bring borrowers (buyers) and savers (sellers) together Banking System - Duel regulation system (state & national level) - Fractional Reserve System (Everything you put in doesn’t stay there) - Can a bank create money? Yes! Via Lending! Banks - Financial Intermediary - Do they keep all of my money in a vault? - NO, only a fraction - Can banks make money? -YES, by making loans - What is the goal of a bank? - To make money! M=I/R (Money Multiplier =where the money ends up) Sometimes folks don’t think too highly of bankers - Are we becoming a cashless society? YES - What would that mean? MICROCHIPS/ PATCHES ON THE BODY THAT HOLD INFO - Who would favor? GOVERNMENT, FOR TAX PURPOSES Federal Reserve Bank - Established 1913 *** - Central banking system -JOB: 1. Control Monetary System 2. Implement Monetary Policy 3. Supervise Commercial Banks (bankers’ bank) The Fed and Fed’s Board of Governors - 7 members - Appointed by U.S. president with approval from Senate - 14 year term (typically don’t complete) - The Chair of Board of Governors is leading official - 12 Federal Reserve District Banks - Total of 25 branches Who Runs the Fed? - Board of Governors (B.O.G.) - Chairman - 12 District Fed Banks (Each with own president) - FOMC/Federal Open Market Committee - 7 members of the B.O.G and 5 presidents of the district banks - Always the NY president with the others rotating - Decision making committee What are banks to do when they are going under? FAIL or be BAILED OUT Quantitative Easing (QE): Federal Reserve open market purchases intended to generate an increase in bank reserves at nearly zero interest rates Fed Bank In NY - Special - Due to size of transitions - NY Fed Bank President is always part of FOMC - Featured in movie “Die Hard”; producers were not allowed inside. - There is LOTS of gold in there; gold has intrinsic value Feds Tools of Monetary Policy - Discount Loans (Feds loans to Commercial Banks) - Reserve Requirements (You must keep XXXX on reserve with us) - Open Market Operations (buying/selling treasury securities) ***MORE INFO BELOW To stop inflation you must press the breaks on the economy – slow things down. Discount Loans - “Lender of Last Resorts”: The Fed’s role as an institution that is willing and able to lend to a temporary liquid bank that is otherwise in a good financial condition to prevent the bank’s liquid position from leading to a general loss of confidence in the bank or in others. - Reds lending to commercial banks - Discount rate – Interest rate is fixed by bank - Small activity Open Market Operations - Buying/selling government securities - Key tool of monetary policy - Flexible Fractured Reserve - Multiplier = I/R - Simple multiplier – not realistic - Banks create money by lending - Banks are pro-cyclical - Cannot force bank to lend and you cannot force people to borrow M1 + M2 (Money Categories) - Used by Feds M1 – very liquid, smallest measure - Currency - Transaction deposits M2 - M1 - Savings - Small Time Deposits Mortgage Meltdown - Cheap Money - Fed post 9/11 - Create Bubble (over investment in a market until it pops) - Comm. Reinvestment Act of 1977/94 - gave directions to industries on lending money to buy homes - encourage (FORCED) certain loans - Housing Issues (Home Ownership) - Traditionally 64% jumped to 69% - Core issue of economic downturn Fannie Mae/Freddie Mac - make market in mortgage industry - buy mortgage loans (market makers) - GSE = Government Sponsored Enterprise - Privately owned - But, subject to congressional oversight Sub Prime Loans (Low qualifications) -Loans became easier to get - ARM - No Documentation necessary (just a few pay stubs) - Zero Down (no down payments necessary) Predatory Lending - Some mortgage lenders went this route - Focus on consumer ignorance - Frequent Re-financing Wall Street? - Mortgage Bundling - Securitization (selling as securities) - “Toxic” Mortgages Supply Side Economic - grow the economy HOW? - Lower Tax Rates = Tax Revenues - Laffer Curve -Less regulations on businesses
Are you sure you want to buy this material for
You're already Subscribed!
Looks like you've already subscribed to StudySoup, you won't need to purchase another subscription to get this material. To access this material simply click 'View Full Document'