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CSU ECON 204 - Exam 2 Study Guide

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Exam # 2 Study Guide Lectures: 7 – 13Lecture 7 (February 12th)Income and ExpendituresA household (in the basic sense) chooses either to consume or save. Marginal propensity to consume (MPC) is the increase in consumer spending when disposable income rises by $1. The MPC is between 0 and 1.Marginal propensity to save (MPS) is the increase in household savings when disposable income increases by $1.MPC+MPS= 1 dy= disposable income (can also be noted yd)MPC= change in consumption/dyMPS=change in savings/dyThe multiplierMultiplier: shows how initial changes in spending lead to further changes.Total spending = change in spending(m)Spending= C+I+GIn the end real GDP increases by more than the initial amount rise in consumption spending. Total consumption (on graph) = MPC(dy) +a <- linear graphThe aggregate consumption function shows how disposable income affects consumer spending. Lecture 8 (February 17th) Planned Investment SpendingPlanned investment spending is the investment spending that businesses plan to undertake during a given period. Planned investment spending depends negatively on interest rates and existing production capacity (Maximum level of output)Planned investment spending depends positively on expected future real GDP. Expected future sales have a positive effect on investment spending and the current level of productive capacity has a negative effect on investment spending. Therefore, firms will be more likely to undertake high levels of investment if they expect sales to increase quickly. This growth of sales will take up excess capacity and encourage investment. Inventory InvestmentEcon 204 1st EditionInventories: stocks of goods held to satisfy future salesInventory investment: the value of the change in total inventories held in the economy during a given periodUnplanned inventory investment: occurs when actual sales are more or less than businesses expect, leading to unplanned changes in inventories.Actual investment spending is the sum of planned investment spending and unplanned inventory investment. Lecture 9 (February 19th) Aggregate Demand The aggregate demand curve shows the relationship between the aggregate price level and the quantity of aggregate output demanded by households, businesses, the government andthe rest of the world.When considering the aggregate demand curve we consider one simultaneous change in theprices of ALL final goods and services. Why the ADC is downward slopingThe aggregate demand curve is downward-sloping firstly because the wealth effect of a change in the aggregate price level (higher aggregate price level reduces the purchasing power of a household, reducing consumer spending) and secondly because of the interest rate change (a higher aggregate level which reduces purchasing power leads to a rise in interest rates and a fall in investment and consumer spending).A movement down the aggregate demand curve leads to a lower aggregate price level and higher aggregate output. (Y-axis = aggregate price level, X-axis = Real GDP)Shifts of the ADCThe aggregate demand curve shifts due to:1. Changes in expectations2. Changes in wealth3. The stock physical capital4. Government policies (Fiscal and monetary)Lecture 10 (February 24th) Aggregate Supply Aggregate supply curve: shows the relationship between the aggregate price level and the quantity of aggregate output in the economy.Nominal wage: is the dollar amount of the wage paid.Sticky wages: nominal wages that are slow to fall even in the face of high unemployment andslow to rise even in the face of labor shortages.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.Shifts in short-run aggregate supplyShifts in the short-run aggregate supply curve are caused by changes in:1. Commodity prices2. Nominal wages3. Productivity leading to changes in producers’ profits Long-run aggregate supply curveThe 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.Macroeconomic EquilibriumThe AS-AD model uses the aggregate supply curve and aggregate demand curve together to analyze economic fluctuations. Short-runShort-run macroeconomic equilibrium: when the quantity of aggregate output supplied is equal to quantity demandedShort-run equilibrium aggregate price level: the aggregate price level in the short run macroeconomic equilibriumShort-run equilibrium aggregate output: the quantity of aggregate output produced at the short-run macroeconomic equilibriumLong-runThe economy is in long-run macroeconomic equilibrium when the point of short-run macroeconomic equilibrium is on the long-run aggregate supply curveRecessionary gap: when aggregate output is below potential outputInflationary gap: when aggregate output is above potential outputOutput gap: percentage difference between actual aggregate output and potential outputOutput gap = ((actual aggregate output – potential output) / potential output) x100Demand and supply shocksThe economy is self-correcting when shock to aggregate demand affect aggregate outputin the short but not the long run. An initial negative demand shock reduces the aggregate price level and aggregate outputand leads to higher unemployment in the short run until an eventual fall in nominal wages in the long run increases short-run aggregate supply and moves the economy back to potential output. If a recession occurs from a supply shock it is more likely to be severe than from a demand shock. Fiscal policy affects government spending and monetary policy affects investment. It is desirable to raise both government spending and investment to bring up aggregate demand.Stagflation: high inflation combined with high unemployment and stagnant demandLecture 11 (February 26th) Fiscal Policy Free rider problem: if free goods and/or services are provided everyone will try to get themThe economy is self-correcting in the long-run. Stabilization policy: use of government policy to reduce severity of recessions. Evidence fromthe past has shown that stabilization policies are stabilizing.Policy in the face of demand shocks – price stability is generally regarded as a desirable goal and to promote full employment (goals of the fed). Responding to supply shocks


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