79 Cards in this Set
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Assumptions of the Classical Model
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Rational self-interest
Market clearing
No money illusion
Diminishing marginal returns
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Money neutrality
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A change in the money supply that has no effect on real variables, only nominal variables.
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Say's Law
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Supply creates its own demand. During production, enough income is generated to purchase the output; if not, prices adjust. Therefore, overproduction is not possible.
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Classical dichotomy
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The idea that real variables can be separated from nominal variables. Real variables are determined by other real variables, and nominal variables are determined by other nominal variables.
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Crowding out effect
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When an ⇑ in government spending will lead to an increase in real interest rates. causing investment & consumption spending to decline.
Complete crowding out: When an ⇑ in government spending is exactly offset by declines in private spending.
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Market for loanable funds
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Connects lenders, who can earn interest payments on excess funds, to borrowers, who are willing to pay interest to use those funds for investment or consumption. Classical model states real interest rates adjust so that saving is equal to investment
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Labor Market
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An informal market where workers find paying work, employers find willing workers, and how wage rates are negotiated and affect employment and labor.
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Aggregate Supply (Classical Model)
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Shows quantity of output firms & workers are willing & able to produce at different price levels. Determined by prices (P) & real GDP (Y). Vertical in classical because real GDP is the same at all price levels due to market clearing).
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Aggregate Demand (Classical Model)
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Quantity of labor that employers are seeking to utilize at different price levels. Determined by price levels (P) and real GDP (Y). As real GDP increases, prices decrease exponentially.
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Production Function
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Model showing relationship between quantity of labor employed in economy (L) & amount of real GDP produced (Y). As labor ⇑, real GDP ⇑, but at decreasing rate due to law of diminishing returns. Assumes capital and technology are held constant.
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Price level versus wage rate
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Price level is a hypothetical measure of overall prices for some set of goods and services.
Wage rate is the total compensation to labor.
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Assumptions of the Keynsian Model (pg 172)
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Rational self-interest
Price level is fixed
INterest rates are fixed
GDP = National Income
Consumption spending depends on income
Investment, government spending and exports are fixed
Imports are autonomous
Taxes are equal to zero
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Consumption Function (pg 173)
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A model that shows the relationship between consumption spending and disposable income in the economy. (b = MPC)
C = C0 + bYd
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Saving Function (pg 173)
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Describes the relationship between saving and disposable income in the economy found by subtracting the consumption function from disposable income (1-b = MPS. MPS + MPC = 1).
What you're consuming, you can't save.
S = -C0 + (1-b)Yd
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Import Function
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Describes the relationship between imports and disposable income in the economy (d = MPIM)
M = M0 + dYd
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I,G,X,M
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I = investment
G = government spending
X = exports
M = imports
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Disposable income
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The difference between national income and taxes in the economy
Yd = Y - T
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Aggregate expenditures
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The sum of consumption, investment, government and net export spending in an economy.
AE = C + I + G + (X-M)
Shows the amount of total spending in the economy at different levels of income
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Y = AE in Equilibrium
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Occurs where output in the economy is equal to spending, or where real GDP is equal to aggregate expenditures.
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Spending multiplier
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Occurs because one person's spending becomes another's income, and determines the effect spending disposable income has on aggregate expenditure and real GDP.
(1/(MPS) x AE0
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Tax multiplier
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An increase in taxes will reduce real GDP, while a tax cut will increase real GDP.
(-MPC + MPM) / (1 - MPC + MPIM)
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Tax multiplier = 1 – spending multiplier
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Derived from the spending multiplier and tax multiplier formula, shows the relationship of increases or decreases in taxation relative to changes in real GDP.
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Paradox of Thrift
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An increase in saving will reduce GDP since an increase in saving means a reduction in consumption spending.
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Keynsian Cross Diagram
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Shows equilibrium in the fixed-price Keynesian model, as exemplified by both the actual AE and Y=AE.
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Aggregate Demand (AS/AD Analysis)
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Model that shows the desired spending that consumers, investors, governments and the foreign sector are willing and able to purchase at different price levels in the economy.
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Aggregate Supply (AS/AD Analysis)
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Model that shows the amount of desired output that firms and workers in the economy are willing and able to produce at different price levels.
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Determinants of AD (pg 200)
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Any variable that causes a change in AE will cause a change in AD.
C, G, I, net export.
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Determinants of AS
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Resource prices, technology, business confidence, quantity of resources, capacity utilization, value of the dollar, business taxes and regulation.
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Equilibrium
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The quantity of desired spending is just equal to the quantity of desired output, or spenders in the economy are purchasing just the quantity of output that firms and workers want to purchase.
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Capacity utilization
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The amount of factory capacity in the economy that is currently being utilized, or how much factory space and time is being used up compared to the maximum that could be used.
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Real Income (wealth) effect
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⇑ in wealth will lead to increased consumption spending b/c consumers feel richer & spend more, while decreases in wealth lead to ⇓ in consumption spending/reduce the growth of consumption spending.
As price level ⇓, consumption spending increases.
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Interest Rate Effect (pg 197)
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As interest rates decline, more investment opportunities become profitable for firms because they owe less interest.
P↓ → money demand↓ → i↓ → I↑ → AE↑ → Y↑
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Net export effect
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An increase in exports or decrease in imports increases net exports, which will increase aggregate demand.
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Ordinary Upward-Sloping AS
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A compromise between the extreme versions of the ASC shows that as price level in the economy increases, firms and workers will desire to produce a greater quantity of real GDP because they will earn more revenue for each unit of output.
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Neo-Keynesian AS (pg 220)
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3 ranges depending on how far eco. is from full em.: when real GDP is far below full em., AS curve = horizontal; approaching full em., curve = upward sloping; when eco. is @ or beyond full em., AS becomes vertical as eco. reaches limits of production
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Neo-Classical AS (pg 222)
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2 distinct AS curves:
In the short run, wages are fixed & workers in the economy suffer $ illusion. At full employment, upward sloping.
In the long run, wages are flexible & there is no $ illusion. At full employment, vertical sloping.
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Discretionary fiscal policy
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occurs when the government decides to change government spending or taxes through changes in legislation or regulation to influence the macroeconomy. Requires action by the the government.
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Automatic stabilizers
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Government policies & programs that reduce the volatility of the business cycle by moderating fluctuations in income.
Progressive income taxes
Unemployment insurance
Welfare programs
Agricultural price supports
Stability of government spending
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GDP Gap
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The difference between actual real GDP and potential real GDP
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Supply-side economics
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Idea that government could influence the supply side of the economy through income tax cuts and deregulation to help stimulate the economy
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Recessionary Gap
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Increase in AE required to bring the economy to full employment when actual real GDP is less than potential GDP.
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Inflationary Gap
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Decrease in AE necessary to return the economy to full employment when actual real GDP is less than potential GDP.
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Budget deficit
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Difference between government spending and tax revenues for a given year; the government is spending more than it is receiving in taxes.
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National debt
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The sum of all funds the government owes to all of its creditors that have not yet been paid off, and is cumulative.
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Progressive tax system
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Average income tax rates increase as income increases; high income people pay a higher percentage of income than low income people.
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Proportional tax system
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Average tax rate is constant as income increases; all income classes pay the same percentage of their income tax.
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Regressive tax system
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Average tax rate declines as income increases; low income people pay a higher percentage of income than high income people.
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Twin deficits
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When the economy has both trade and budget deficits.
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Laffer curve
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As income rates (t) ⇑, tax revenue (T) 1st rises then falls - at 0% rates, there is no revenue bc there are no taxes, & at 100% rates nobody will work. Curve shows that there is some ideal tax rate in b/w 0 - 100% that will maximize tax revenues.
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Functions of money
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Medium of exchange
Unit of account
Store of value
Standard of deferred payment
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M1
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Measurement of money consisting of currency and coins, checking accts deposits (demand deposits), travelers' checks, and other checkable deposits; are assets almost everyone is willing to accept in exΔ for goods and services or as payments for debts.
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M2
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Measure of money consisting of all of M1, small denomination deposits, savings deposits, money market deposit accounts, and non-institutional money market mutual funds.
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M3
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Largely no longer used, a measure of money consisting of M2, large denomination time deposits, institutional money market mutual funds, repurchase agreements, and term Eurodollars.
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Commodity money
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An asset that has an intrinsic value apart from its use as money.
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Fiat money
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An asset that is acceptable because the government says it is.
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Gresham's law
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Bad money (money that is worth more than its face value) drives good money out of circulation when they are set at the same exchange rate by law.
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Equation of exchange (MV = PY)
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Formula that relates the amount of spending w/ the amount of production; money in the economy has to circulate enough times to purchase all of the goods & services produced in nominal GDP.
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Quantity theory of money (pg 147)
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When velocity and real GDP are constant in the equation of exchange; any change in the money supply will lead to a proportionate change in the price level.
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Monetarist model
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States that the most important economic variable is the rate of growth of the money supply; if the velocity is stable, then a stable rate of growth of real GDP can be achieved through a stable growth in the money supply.
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Keynesian Model
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Velocity and real GDP not stable, demand for money plays greater role in determining real GDP.
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Money Supply
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Fixed by the central bank and is independent of interest rates; curve is vertical
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Money demand
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Depends on three factors:
transactions demand
precautionary demand
speculative demand
Curve is downward sloping
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Investment Function
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Downward sloping with respect to investment expenditures and interest rates.
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AS/AD
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increase in money supply ⇒ decrease in interest rates ⇒ increase in investments ⇒ increase in AD
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Federal Reserve System
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Established to provide a pool of reserve funds for member banks
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Functions of the Fed
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Conduct monetary policy
regulate and supervise banks
maintain financial stability, provide financial services to the US government, financial institutions, and the public
operate under the nation's payment system
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FOMC
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Consists of seven members of the Board of Governors, NY Fed President and four other Federal Reserve Bank Presidents, and meets to assess the economy and set a direction of monetary policy.
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Tools of monetary policy:
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Open market operations
Discount lending
Reserve requirements
Informal powers
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Open market operations
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Influence the quantity of reserves held by banks, usually by adjusting the federal funds rate.
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Discount lending
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Loans that the Fed takes directly to member or commercial banks from a lending facility known as the discount window.
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Reserve requirements
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A change in the required reserve ratio will lead to a change in the money multiplier.
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Informal powers
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Persuasions or motions of force that the Fed can use to get banks and other reserve institutions to influence the money supply.
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Ben Bernake
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Chairman of the Federal Reserve Bank circa February 1st, 2006.
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Term Auction Facilities
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A temporary program managed by the United States Federal Reserve designed to "address elevated pressures in short-term funding markets."
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Federal funds rate
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The rate at which banks lend funds at the Federal Reserve to other banks; the interest rate banks charge each other for loans.
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Discount rate
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Interest rate that the Fed charges member banks to borrow reserves.
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Mortgage-backed security (MBS)
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An asset-backed security or debt obligation that represents a claim on the cash flows from mortgage loans.
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Collateralizd Debt Option
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A type of asset-backed security whose value and payments are derived from a portfolio of fixed-income underlying assets.
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Certificate of Deposit
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A time deposit, similar to savings accounts in that they are insured, usually has a fixed term and interest rate for deposit.
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ECON 162: Final