Macroeconomics Final Exam (concepts)

Micro deals with the interactions and decisions of individual households as well as firms. Macro deals with the economy as a whole.

The market value of all final goods and services produced within a country in a given period of time.

Consumer spending, Investments, Government Spending and Net Exports (Imports and Exports)

Y=C+I+G+NX

Nominal determines value according to current prices (quantity and price) whereas Real determines value according to constant, base-year prices (quantity only)

The formula for real GDP is nominal GDP divided by the deflator, or R = N/D.
The formula for nominal GDP is GDP = (quantity of A X price of A) + (quantity of B X price of B) + (quantity of C X price of C).

living standards, Pollution effect, Double Counting, Un-reported Self activities, illegal economy, statistical errors

An economies production of goods and services.

A measure of the level of prices of all new, domestically produced, final goods and services in an economy

(nominal GDP/Real GDP)*100

Inflation rate=(GDP deflator 1-GDP deflator 2/ GDP deflator 1)*100

A measure of the overall cost of the goods and services bought by the typical consumer

CPI=(price of g&s in current year/price of g&s in base year)*100

Inflation rate in Year 2= (CPI in year 2-CPI in Year 1/CPI in year 1) * 100

Substitution Bias, Introduction of New Goods, Unmeasured Quality Change

Amount in Today’s Dollars= Amount in year T dollars * (price level now/price level in year T)

GDP Deflator reflects the price of all goods and services produced domestically while the CPI reflects the price of all goods and services bought by consumers. CPI compares the price of a fixed basket of goods and services in a base year whereas GDP deflator compares the price of currently produced goods and services to the price of the same goods and services in a base year.

Automatic correction by law or contract of a dollar amount for the effects of inflation.

Real- interest rates corrected for the effects of inflation. Nominal- interest rate as usually reported, without a correction for the effects of inflation.

Real Interest Rate = Nominal interest rate – Inflation rate

The quantity of goods and services produced from each unit of labor input.

Physical Capital: the stock of equipment and structures used to produce goods and services.
Human Capital: the knowledge and skills that workers gain through education, training and experience.
Natural Resources: Inputs into production that are provided by nature.
Technological Knowledge: the understanding of the best way to produce goods and services.

L-labor, K-physical capital, H-human capital; N-natural resources
in terms of actual variables- Y = A F(L, K, H, N)
in terms output per worker- Y/L = A F(1, K/L, H/L, N/L)

A production function exhibits constant returns to scale if changing all inputs by a positive proportional factor has the effect of increasing outputs by that factor

One way to raise future productivity is to invest more in the production of capital. For people to invest more in capital, they must consume less and save more income.

As the stock of capital rises, the extra output produced from an additional unit of capital falls.

Poor countries with the same pro-rata share of investment (or increase in the saving rate) tend to grow more rapidly than rich countries, but due to diminishing returns, that growth is temporary.

Foreign Investment: higher productivity growth
Education: higher education= higher productivity
Health and Nutrition: healthier workers are more productive
Property rights and political stability: protection of property rights and political prosperity increase productivity
Free trade: free trade policies allow for better productivity
R&D: leads to profit which provides incentive for better productivity
Population Growth: more subtle effect, more people=more workers but more people also = more consumers

Savings: total income in the economy that remains after paying for consumption and government purchases. Investment: the purchase of new capital.

When government must finance its spending with taxes and/or with deficit spending, leaving businesses with less money and effectively “crowding them out.”

Government financing of projects with deficit spending through the use of borrowed money. Because the government borrows such large amounts of capital, its activities can increase interest rates. Higher interest rates discourage individuals and businesses from borrowing money, which reduces their spending and investment activities

-Does not account for those who left the job search after turning up dry.
– it is exaggerated by those who say they are unemployed but may just simply not want to work.

Most spells of unemployment are short, and most unemployment observed at any given time is long-term.

Refers to the amount of unemployment that the economy usually experiences.

Refers to the year-to-year fluctuations in unemployment around its natural rate, and it is closely associated with the short-run ups and downs in economic activity.

(sectional shifts: demand or consumer preference changes) occurs because of the time it takes for a worker to search for a job that is best suited to his skills

(labor market specific) occurs because the number of jobs available in some labor markets are insufficient to provide a job to everyone that wants one.

The body of law which prohibits employers from hiring employees or workers for less than a given hourly, daily or monthly minimum wage

An organization intended to represent the collective interests of workers in negotiations with employers over wages, hours and working conditions.

A higher than market-clearing wage set by employers. The argument is that paying workers a higher wage may lead to increased productivity from the worker.

A government program that partially protects workers incomes when it comes to unemployment.
-How it helps, how it doesn’t : reduces the hardship of unemployment, yet also causes unemployment when seen as incentive.

The set of assets in an economy that people regularly use to buy goods and services from other people.

Medium of exchange, unit of account and a store of value

The ease with which an asset can be converted into the economy’s medium of exchange.

Commodity money: money that takes the form of a commodity with intrinsic value.
Fiat money: money without intrinsic value that is used because of government decree.

The paper bills and coins in the hands of the public.

Balances in bank accounts that depositors can access on demand by writing a check.

Federal Reserve is the central bank (an institution designed to oversee the banking system and regulate the quantity of money in the economy) of the US.

Supply- the quantity of money available in the economy. Demand- amount of wealth people want to hold in liquid form.

-M1, M2: M1 is currency and demand deposits whereas M2 is M1 plus more liquid assets like savings deposits.
-Reserves: deposits that banks have received but not loaned out.

A simplified accounting statement that shows changes in a banks assets and liabilities.

Fractional- the widespread banking practice in which only a fraction of a bank’s demand deposits are kept in reserve and available for immediate withdrawal. The practice of fractional reserve banking expands credit and therefore also expands the money supply. 100%-banks treat deposits in a similar way to allocated gold accounts, where the money cannot be lent out for extended periods of time as the money is held in trust on behalf of the client. In this system, only those funds from depositors who voluntarily kept their money with the bank for an extended period would be available for lending to third party borrowers.

The portion (expressed as a percent) of depositors’ balances banks must have on hand as cash.

The money multiplier is the reciprocal of the reserve ratio. (MM=1/R)

Open Market Operations (Most Used): the purchase and sale of US government bonds by the feds. (feds loans to banks to increase reserves and money supply)
-Reserve Requirements: regulations on the minimum amount of reserves that banks must hold against deposits.
-The Discount Rate: The feds loans to banks to increase reserves and money supply

The Fed does not control the amount of money households choose to hold as deposits in banks. The Fed does not control the amount that bankers choose to lend.

1/P

The quantity of money available in an economy determines the value of money and growth in the quantity of money is the primary cause of inflation.

Quantity of Money Demanded (Md) is positively related to price level (P) and negatively related to the value of money

– Real Variables are expressed in physical units (or in the case of Real GDP constant dollars or the real interest rate in purchasing power. The real interest rate in the loanable funds model measures the rate people exchange g&s today for g&s in the future.)
– Nominal Variables are expressed in monetary units.

the price of one thing compared to another

real wages are adjusted for inflation and are not effected by a change in money supply whereas nominal wages are effected by a change in the money supply.

the theoretical separation of real and nominal variables.

irrelevance of monetary changes for real variables.

V= (PxY)/M

MxV = PxY

refers to the rise in price levels when the government creates money.

inflation that exceeds 50 percent per month.

-Shoe leather costs: resources wasted when inflation encourages people to reduce their money holdings.
-menu costs: the cost of price adjustments
-relative price variability & misallocation of resources: when inflation distorts relative prices, consumer decisions are distorted which causes markets to be unable to allocate resources to their best use.
– inflation induced tax distortions: inflation tends to exaggerate capital gains which inadvertently causes a tax burden on income earned from savings.
arbitrary redistributions of wealth: unexpected redistributions of wealth among the population occur because many loans in the economy are specified in terms of the unit of account (money).

the adjustment of nominal interest rate to the inflation rate. If the Fed increases the rate of money growth the long-term result is s higher inflation rate as well as a higher nominal interest rate.

open economies interact freely with other economies around the world whereas closed economies do not interact with them at all.

• NX= X- M(imports)

consumer tastes, prices of goods, consumer’s income, exchange rates, transportation coasts and government trade policies.

NCO (net capital outflow)= FAPdom (foreign purchase of domestic goods) – DAPfor (domestic purchase of foreign goods)

real interest rates on both foreign and domestic assets, perceived economical and political risks of holding assets abroad and the government policies that affect foreign ownership of domestic goods.

direct: investment that is actively managed
portfolio:investment that is more passively managed

The rate at which a person can trade the currency of one country for that of another.

appreciation occurs when the exchange rate changes so a dollar buys more foreign currency whereas depreciation occurs when the exchange rate changes so a dollar buys less foreign currency.

Real Exchange rate = (e*P)/P*
where P= domestic price (or price level), P*= foreign price (or price level)

Goods should sell at the same price in all markets

– A unit of any currency should be able to buy the same quantity of goods in all countries
– e= P*/P
– Real exchange rates should be 1 in this case

nominal exchange rates change when price levels change, not all goods are easily traded and not all tradable goods are of equal quality.

the market for loanable funds and the market for foreign currency exchange.

represents negative public saving. When the government runs a budget deficit the supply of loanable funds goes down which drives up interest rates and crowds out investment. When the interest rate goes up, net capital outflow is reduced. This causes the supply curve to shift to the left.

a large and sudden reduction in the demand for assets in a country. When this happens investors around the world sell their assets from said country which drives up net capital outflow which (by effecting the supply of their currency in the market for foreign currency exchange) increases the demand for loanable funds. On top of this, interests rates increase which causes the currency to depreciate.

an increase in NCO causes an increase in the demand for loanable funds which causes interest rates to increase. The increase in NCO also causes and increase in supply of currency which causes the currency to depreciate driving the real exchange rate down.