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Macro Final Study Guide

by: Ashna Kapoor

Macro Final Study Guide ECON 1012

Marketplace > Economcs > ECON 1012 > Macro Final Study Guide
Ashna Kapoor

Principles of Economics II (ECON 1012)
Roberto M. Samaniego

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Here is a study guide for the Macro exam!
Principles of Economics II (ECON 1012)
Roberto M. Samaniego
Study Guide
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This 0 page Study Guide was uploaded by Ashna Kapoor on Tuesday December 8, 2015. The Study Guide belongs to ECON 1012 at a university taught by Roberto M. Samaniego in Fall 2015. Since its upload, it has received 18 views.


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Date Created: 12/08/15
Macroeconomics Study Guide Aggregates a measure of the sum of lots of things Givens an overall picturequot of something Aggregate Demand 0 People companies government other countries 0 Aggregate demand Curve The relationship between rGDP that people would want to buy vs the price level YClGXIM Consumption 0 part that households consume 0 depends on how much wealth you have 0 how much income you have comin in o Disposable income Y transferstaxes What affects consumption 0 Price level a Consumption l effect on nominal wealth and maybe income Even if Y is constant Taxes a C l changes DI Even if Y is constant Transfers a C changes Di 0 This is important it suggests that one might be able to in uence aggregate demand using taxes and transfers 00 Aggregate Supply 0 Companies produce output to maximize their bene t pro ts Combine and use inputs Inputs capital labor land intermediate foods Output beanie babies bombs cars In between technology 0 Aggregate Supply Curve relationships between the price level and output LRAS vertical Price level doesn t matter because relative prices wont change 0 What moves the LRAS Changes in input technical change education 0 SRAS sticky wagesquot long term contracts less uncertainty decreasing returns Entry exit and the number of rms 0 What moves the SRAS Changes in wage prices of other inputs changes in technology Price Level rGDP Potential IGIDP rGDP What is GDP GDP Gross Domestic Product everything that was produced over a particular period of time in a particular place Nominal GDP sum of the market value of all nal goods and services produced over a particular period of time in a particular place 0 Final goods a sandwich 0 Intermediate good the bread in the sandwich the labor used to make 0 Nominal GDP cant distinguish price rises from increases in production 0 Measure by add all spending on goodsservices Real GDP take out price effects The rate of increase in production growth In ation the rate of increase in prices Price Level a price aggregate average pricesquot several ways of going about it 0 GDP de ator GDP De ator Nominal GDPReal GDP x 100 If you want to see overall in ation use the real GDP de ator o CPI index CPItota price of the basket today x 100 total price of basket in base year If you want to know how in ation is affecting consumers use CPI example redistribution Substitution Products with prices that drop relatively tend to have faster growth in quantities applies to rGDP too Quality Change Rising prices may re ect improvements not in ation perse New goods New goods may replace old ones and be more expensive they are better or do new things O PPl index same formula as CPI If you want to know how in ation is affecting companies use PPl example forecasts If there is economic growth 0 O O OO O O The quantity of inputs is increasing or You are getting more output from the same quantity of inputs how come Neoclassical Solow Technical change drives growth Technical change new technology new production new methods Cause capital accumulation growth eventually stops Theorists point out that aside from physical caital it might be worth thinking as the accumulated skills of the workforce as a kind of capital Human Capital 1 When there is a discovery rGDP rises T 2 People save some of the new income 3 Since savings have risen there is more investment also rGDP rises further K 4 As there is more capital the return to capital decreases diminishing returns so there is less incentive to invest won t get as much pro ts or to save won t get as much interest Go back to stage 2 5 Eventually growth stops New growth theory Schumpeter Romer Technical change doesn t just happen by accident people try to invent things or new better ways of producing things People try to invent things because they earn pro ts by selling them Costly but people do it because they nd it interesting status pro t Some people copy ideas 0 Intellectual property rights patents Motor of growth is production of new items Institutional theories a bigger picturequot approach Property rights without them little point in even investing at all Financial development what if borrowers can t nd lenders quotOpennessquot access to outside ideas and markets Two parts to technology T a things like scienti c advancement and b institutions 0 If there are business cycles it must be that o The quantity of inputs used isn t steady or o The output produced by a given quantity of inputs isn t steady Money money means of exchange something widely accepted as payment 0 commodity money salt pepper metals etc o at money value not connected to its nonmonetary use 0 use for means of payment unit of account political too Liquidity ease with which something be converted into money Money Supply the quantity of money in circulation in use M1 currency coins and checking deposits M2 M1 saving deposits and other things Balance sheets Liabilities sources of funds deposits 0 Checking depots other deposits borrowings discount loans federal funds bank capital Assets uses of fund reserves loans securities Liabilities and Assets must be equal Bank capital has certain requirements does not want it to be negative or bank is closed Bank Regulation 1 Reserve requirements required vs excess 2 Deposit insurance moral hazard 3 Bank supervision 4 Limitations on risk to avoid both bank runs and insolvency Central Banks supervise banks The banks bank most reserves are actually deposits at the central bank Lender of last resort Tries to control the money supply Monetary base controlled by the centeral bank central bank does NOT have control over money supply MB currency coins reserves Open market operations central bank buys or sells securities usually bonds Reserve requirements Making loans to banks Open Market Purchase 1 Securities decrease reserves increase 2 Deposits haven t changeda the reserves are excess 3 The bank loans them out pro ts 4 The loan is spent 5 Deposited at seller s checking account AMs 6 New reservesapart excess deposit multiplier 1reserve ratio Multiplier is affected by open market operations discount loans the discount rate anything that changes the multiplier Investment what determines how much investment there is 0 Companies maximize pro ts Capital is used to produce earn pro ts Capital lasts over a long period Investment is determined by expected future pro ts So basically investment is affected by business con dence expectations interest rates cost of borrowing and 00000 taxation reduced pro fts How does investment relate to pro t 0 Consumer spending depends on real wealth current income and expected future income 0 For companies it s the same Retained pro tsquot pro ts the company kept instead of paying the owners Current pro ts Can also borrow against future pro ts 0 Generally borrow since if it is pro table it should make more money than it costs aPrice level not thought to matter much directly 0 You can borrow through a bank loan b Where do funds come from 0 Savings Peoples personal savings companies savings government savings foreign lending Investment is funded by savings borrowing is funding by lending price of these funds interest rates I Savings should slope up investment slopes down Crowding out effect If government spending increases this increases interest rates and decreases the amount of investment I Savmgs I I igt 3 Exports and lmports What affects the quantity of goods people purchase that are made elsewhere X depend on income abroad and on prices of foreign vs domestic goods and exchange rates lm depend on income at homequot and on prices of foreign vs domestic goods and exchange rates Law of one price 0 Purchasing Power Parity macro equivalent o If PPP holds then any change in the price level leads to a change in the exchange rate that offsets it 0 Exchange rates should re ect movements in price levels in different countries 0 What does this meanhow does it apply If the price level increases in the US the exchange rate doesn t react for a while so 0 US goods become more expensive abroad 0 Foreign goods look cheap 0 Exports drop lmports increase Exchange Rates the price of one currency in terms of another exchange rates and Aggregate Demand 0 Suppose that we are in the US The US trades a lot with the European Union 0 Suppose the US gains value against the Euro 0 US buys more euros euros buy fewer US 0 US buys more european goods euros buy fewer US goods o All this occurs because purchasing power parity takes some time o If the US dollar gains value European goods look cheap to Americans buy more 0 If the US dollar gains value US goods look expensive to Europeans buy less Demand effect 0 US import go up because they are buying more European goods but US exports go down because the Europeans do not want to spend as much on our goods 0 AD ClGxIM goes down When a currency gains value ad drops when a currency loses value AD increases Exchange rate determination 0 Think about why people buy the currencies of other countdes To buy their goods I To buy their assets 0 Law of one price If it is cheap to transport good across countries then their prices should be the same in different countries Example the Big mac in the US and Turkey Money goes where the expected return is highest expected exchange rate changes are part of return Equilibrium Price Levels Short run Equilibrium 0 price level adjust so SRASAD o ASgtAD a rms can t sell everything inventories pile up a cut output and prices 0 SRASltADa inventories run down rms increase production and prices Long run equilibrium 0 when real GDP potential GDP 0 We know that prices and wages eventually adjust so that they are right hence the LRAS 0 We know that this process can take time because wages are sticky 0 Therefore if we are notin long run equilbrium it must be that wages are stuck either too high or too low lF rGDPgtpotential GDP 0 Firms are producing more than usual 0 Firms are hiring more than usual The real wage must be too low 0 Firms are hiring more than usual 000 O O O 0 Firms are ring less than usual Easy to nd work 1 The real wage is too low 2 Unemployment is low labor is cheap 3 Firms will start to have trouble nding workers may offer higher wages to attract them 4 Workers may have better options so they can make more demands on their employers such as higher wages Result Nominal wages rGDPltpotential GDP Firms are producing less than usual Firms are hiring less than usual The real wage must be too high Firms are hiring less than usual Firms are ring more than usual Dif cult to nd work 1 The real wage is too high 2 Unemployment is high labor is expensive 3 Firms are ring people aren t competing for workers as hard as on average 4 Workers may have fewer options so they can make fewer demands on their employers eg may take pay cuts to avoid job loss Result Nominal wages l Stable Unemployment O 0 If we are in long run equilibrium unemployment should be stable natural rate of unemployment If the real wage is too low Unemployment is belowthe natural rate 0 Also there should be more entry and less exit If the real wage is too high Unemployment is above the natural rate 0 Also there should be less entry and more exit Self correcting mechanism 0 o The economy moves towards potential GDP on its own If the economy is not in Long Run Eq the nominal wage should begin to adjust so that the reawage returns to its long run level H 0 However this process takes time So if something happens that knocks about AD or the SRAS then we will be away from potential GDP for a while GDP Suddenly increase what happens AD shifts right new SR equilibrium Price level increases nominal wages are quotstuckquot a real wages are low in ationary gap Eventually wages start to increase too a return to LR equilibrium Can see why it s called an quotin ationary gapquot the price level rises throughout the process When SRAS shifts left the gap is gone Price level 1 Rfs SRAS V 1 GDP GDP Suddenly decreases what happens AD shifts left new SR equilibrium Price eve decreases nominal wages are quotstuckquot a real wages are high recessionary gap Eventually wages start to decrease too a return to LR equilibrium SRAS shifts right gap is elminiated AD recessions 1 rGDP low 2 P low in ation lower than otherwise 3 Unemployment high 4 Eventually wages drop P drops and rGDP increases again AD Booms rGDP high P high in ation higher than otherwise Unemployment low Eventually real wages increase P increases and rGDP drops These are the comovements that have been widely observed which is why demanddriven theories have been so popular thI i Keynesian Theory The If people thinkthere will be a recession there may be one Keynesian Keynes argued that government should avoid them by propping up spendingquot 0 Fiscal policy use G anol T If there is a recession can get out If people know there is scal policy they are less likely to expect recessions 0 Stabilization policy Fiscal policy occurs automaticallyincome taxes capital taxes transfers Money Supply and Aggregate Demand there is a form of stabilization policythat is called monetary policy changing the money supply to affect AD 0 interest rates the central bank affects the cost of borrowing In the short run wages are sticky o If your increase money supply the price of everything increases except wages 0 Real wages are low 0 lncentive invest more 0 If you increase money supply then investment increases Aggregate demand shifts right Money Supply and Investment 0 Money supply depends on what the central bank desires o If interest rates increase the opprutnity cost of holding resvers increases Reserve tatios decrease Multiplie increases Money supply increases in investment Money Demand 0 The amount of money people want to hold or demand depends on interest rates 0 The higher the interest rate the higher the opptunrtiy cost demand for money decreases Fiscal vs Monetary Policy 0 Some debate over which is more effective keynesians are activist regarding scal policy Some think activist scal policy ampli es uctuations The government could be wrong about whether or not there is a recession coming 0 Monetary policy acts more quickly Governement takes time to increase or cute spending moved around AD Rational Expectations people make the best forecasts possible given the information they have however 0 Anticipated changes in AD don t matter if people can adjust their behavior in advance 0 Unanticipated ones do We can modify all our policy prescriptions to this model Monetarists 0 Government spending ineffective as a tool 0 Monetary policy far more effective 0 Two type of activisty policy Discretion Rules Why is in ation bad 0 Anticipated in ation does not make a difference Costs of anticipated in ation High in ation goes with high variability Transaction costs search costs 0 Tax effects taxes are nominal lf in ation is high nominal interest rates are high but nominal interest income gets taxed more when in ation is high so the real after tax return is lower 0 Unanticipated in ation redistrubutes income between borrowers and lenders so real costs and bene ts are uncertain Central bank Independence the central bank is part of or at least linked to the government Link between Independence and in ation o Politcal business cycle rGDP and incumbent success are related Fiscalmonetary policy for reelection Relationship to independence Fed Chairman s term is 7 years 0 Monetizing the Debt Borrows a lot every year Effect on willingness to buy the bonds Effect on bond pricesa interest ratesa debt burden Default risk 0 What if central bank buy bonds Open market purchase so money supply increases Pressure to keep the governement from defaulting 0 Government prints money In the extreme case governments and central banks aren t really separate Government can pay its bills by just printing money seignorage


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