132 Cards in this Set
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Flexible exchange rate
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An exchange rate whose value is not officially fixed but varies according to the supply and demand for the currency in the foreign exchange market
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Foreign exchange market
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the market on which currencies of various nations are traded for one another
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Fixed exchange rate
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e rate whose value is set by government policy
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Nominal exchange rate
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Number of units of foreign currency that can be bought for one unit of the domestic currency
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Factors that increase supply of dollars in foreign exchange market...
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Increased preference for Jap goods
increase in U.S. real GDP
increase in real interest rate on Jap assets or decrease in real interest rate on U.S. Assets
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Factors that increase demand for dollars...
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Increased preference for U.S. goods by foreign customers
increase in real GDP abroad
increase in the real interest rate on U.S. Assets"
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Real exchange rate
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The price of the average domestic good relative to the price of the average foreign good, when prices are expressed in terms of a common currency
real exchange rate = price of domestic good/ price of foreign good, in dollars
real exchange rate = (exP)/Pf"
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Law of one price
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If transportation costs are relatively small, the price of an internationally traded commodity must be the same in all locations
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Purchasing power parity
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The theory that nominal exchange rate are determined as necessary for the law of one price to hold
good in long run bad in short run"
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Net capital inflows
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capital inflows minus capital outflows
foreign purchases of domestic assets minus domestic purchases of foreign assets
nothing to do with exports or imports
NX + KI = 0
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National saving and capital inflows
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S+KI=I
the sum of national saving and net capital inflows from abroad must equal domestic investment in new captial goods
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Reason for trade deficits
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Low rate of national saving
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Capital inflows
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When a person, firm, or government borrows from abroad
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Scarcity principle
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Although we have boundless needs and wants, the resources available to us are limited. So having more of one good thing usually means having less of another
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The Cost-Benefit Principle
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An individual should take an action, if and only if, the extra benefits from taking the action are at least as great as the extra costs
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Economic surplus
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The economic surplus from taking any action is the benefit of taking the action minus its cost
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Opportunity cost
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The value of what must be forgone to undertake the activity
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The Incentive Principle
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A person is more likely to tak an action if its benefit rises, and less likely to take it if its cost rises. Incentives matter
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Normative economic principle
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One that says how people should behave
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Positive economic principle
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One that predicts how people will actually behave
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Comparative advantage
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One person has a comparative advantage over another if his or her opportunity cost of performing a task is lower than the other person's opportunity cost
everyone does best when each person concentrates on the activities for which his or her opportunity cost is lowest
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Opportunity cost equation
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OC nuts = loss in coffee/gain in nuts
OC coffee = loss of nuts/gain in coffee
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The Principle of Increasing Opportunity Cost ("Low-Hanging-Fruit Principle)
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In expanding production of any good, first employ those resources with the lowest opportunity cost, and only afterward turn to resources with higher opportunity costs.
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The demand curve
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Schedule or graph showing the quantity of a good that buyers wish to buy at each price
price on y-axis quantity on x-axis
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Substitution effect
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The change in the quantity demanded of a good that results because buyers switch to or from substitutes when the price of the good changes
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Income effect
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the change in the quantity demanded of a good that results because a change in the price of a good changes the buyer's purchasing power
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Buyer's reservation price
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The largest dollar amount the buyer would be willing to pay for a good
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The supply curve
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Graph or schedule showing the quantity of a good that sellers wish to sell at each price
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seller's reservation price
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The smallest dollar amount for which a seller would be willing to sell an additional unit, generally equal to marginal cost
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Market equilibrium
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Occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price
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Change in the quantity demanded
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A movement along the demand curve that occurs in response to a change in price
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Change in demand
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A shift of the entire demand curve
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Complements
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Two goods are complements in consumption if an increase in the price of one causes a leftward shift in the demand curve for the other
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Substitutes
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Two goods are substitutes in consumption if an increase in the price of one causes a rightward shift in the demand curve for the other
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Normal good
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A good whose demand curve shifts rightward when the incomes of the buyers increase and leftward when the incomes of the buyers decrease
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Inferior good
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A good whose demand curve shifts leftward when the incomes of buyers increase and rightward when the incomes of buyers decrease
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Increases in demand are caused by...
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decrease in price of comp.
increase in price of subs.
increase in income for a normal good
increase in the population of potential buyers
expectations of higher prices in the future
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Increases in supply are caused by...
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Decrease in the cost of materials, labor, or other inputs used in production
improvement i technology that reduces the cost of producing the product
improvement in the weather
increase in number of suppliers
expectation of lower prices in the future"
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Seller's surplus
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Difference between the price received by the seller and his or her reservation price
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Buyer's surplus
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Difference between the buyer's res. price and the price he or she actually pays
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Total surplus
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The difference between the buyer's res. price and the seller's res price
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Cash on the table
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Unexploited gains from exchange
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The Efficiency Principle
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Efficiency is an important social goal because when the economic pie grows larger, everyone can have a larger slice
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The Equilibrium Principle
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A market in equilibrium leaves no unexploited opportunities for individuals but may not exploit all gains achievable through collective action
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GDP
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The market value of the final goods and services produced in a country during a given period
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Capital good
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Long-lived good that is used in the production of other goods and services
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Value added
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For any firm, the market value of its product of service minus cost of inputs purchased from other firms
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Consumption
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spending by household on goods and services such as food, clothing, etc.
Consumer durable goods- long-lived such as cars and furniture
consumer nondurable goods- such as food and clothing
services- largest component/such as haircuts, legal, financial
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Investment
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Spending by firms on final goods and services, primarily capital goods
1. business fixed= machinery/office buildings
2. residential= construction of new homes and apartments
3. inventory= addition of unsold goods to company inventories
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Government purchases
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Purchases by federal, state, and local governments of final goods and services; do not include transfer payments
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GDP Equation
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Y = C + I + G + NX
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Real GDP
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A measure of GDP in which the quantities produced are valued at the prices in a base year rather than at current prices; real GDP measures actual physical volume of production
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Nominal GDP
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Measure of GDP in which the quantities produced are valued at current-year prices; measures current dollar value of production
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Consumer price index
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For any period a measure of the cost in that period of a standard basket of goods relative to the cost of the same basket of goods and services in the base year.
CPI = cost of base year basket of goods in current year/cost of base year basket of goods in base year"
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Price index
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A measure of the average price of a given class of goods or services relative to the price of the same goods or services in a base year
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Rate of inflation
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Annual percentage rate of change in the price level, as measured, for example, by the CPI
Inflation rate = (CPI2 - CPI 1)/ CPI1
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Income approach
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GDP = labor income + capital income
labor income is 2/3 of total
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Deflation
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Prices of most goods and services are falling over time so that inflation is negative
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Core rate of inflation
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Rate of increase of all prices except energy and food
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Nominal quantity
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A quantity that is measured in terms of its current dollar value
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Deflating a nominal quantity
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Dividing nominal quantity by price index (CPI) to express quantity in real terms
Real = Nominal/ CPI
Real x CPI = Nominal
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Real wage
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The wage paid to workers measured in terms of purchasing power; the real wage for any given period is calculated by dividing the nominal wage by the CPI for that period
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Indexing
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The practice of increasing a nominal quantity each period by an amount equal to the percentage increase in a specified price index.
prevents nominal quantity from being eroded by inflation
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Substitution bias
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True cost of living and inflation may be exaggerated by CPI because substitution is being ignored
overstates inflation
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Price level
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A measure of the overall prices at a particular time as measured by a price index such as CPI
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Relative price
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The price of a specific good or service in comparison to the prices of otheer goods and services
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CPI adjustment bias
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Does not measure quality change
overstates inflation
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High inflation leads to...
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decrease in plant/equipment investment
cash loses value over time
benefits borrowers not lenders
higher interest rates
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Real interest rate
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annual % increase in purchasing power
r = i - pi
i- nominal
pi- inflation"
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Nominal interest rate
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The annual percentage increase in the nominal value of a financial asset
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Fisher Effect
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The tendency for nominal interest rates to be high when inflation is high and low when inflation is low
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Labor market trends part 1
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Over a long period of time, average real wages have risen in U.S. and other indust. countries
Despite long-term upward trend of real wages, real wage growth has slowed significantly in the U.S. since the early 1970s"
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Labor market trends part 2-
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In U.S. wage inequality has increased in recent decades. Real wages of unskilled workers have declined while real wages of skilled and educated have continued to rise
Until downturn in 2008, employment had been growing much faster than working age pop.
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diminishing returns to labor
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if the amount of capital and other inputs in use is held constant, then the greater the quantity of labor already employed, the less each additional worker adds to production
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marginal product
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"extra production gained by adding one more worker
value of marginal product = worker's m.p. x price of firm's output"
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increases in labor demand due to....
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increase in the price of worker's output or increase in productivity
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employed
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worked full or part time during past week
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unemployed
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did not work during past week but looked for work in the past 4 weeks
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out of the labor force
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"did not work in past week or look for work in past 4 weeks.
students/homemakers/retirees"
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labor force
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employed + unemployed
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unemployment rate
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unemployed people/ labor force
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participation rate
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labor force/16+ population
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long-term unemployment
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unemployed over 6 months
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chronically unemployed
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brief employment with unemployment spells
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discourage worker
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wants a job but didn't look in the past 4 weeks
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involuntary part-time
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wants to work full-time
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frictional unemployment
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"short term/ matching workers with jobs
costs are low"
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structural unemployment
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long-term and chronic that exists in good economy due to language and discrimination
very costly
long term mismatch
union and minimum wage laws
ex. migrant farm workers
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cyclical unemployment
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occur during recessions and are costly
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diminishing returns to capital
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if the amount of labor and other inputs employed is held constant, then the greater the amount of capital already in use, the less an additional unit of capital adds to production
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business cycle
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short term fluctuations in GDP and other variables
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recession
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"period in which the economy is growing at a rate significantly below normal
usually where real GDP falls for at least two consecutive quarters
unemployment and fall in sales of durable goods help indicate recession
often followed by decline in inflation"
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depression
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severe or protracted recession
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peak
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beginning of the recession; high point of economic activity before downturn
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trough
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end of recession; low point in economic activity prior to recovery
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NBER
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not a government agency but treated as the official arbitrator of beaks and troughs
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expansion
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"opposite of recession
period in which economy is growing at a rate way above normall"
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boom
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particularly strong and protracted expansion
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coincident indicators
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"industrial production
total sales in manufacturing
nonfarm employment
real after-tax income
(coincide with overall movements in economy)"
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recesssionary gap
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"negative output gap where potential output exceeds actual output
Y<Y*"
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expansionary gap
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"Y>Y*
often leads to inflation"
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Okun's Law
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one percentage increase in cyclical unemployment leads to a two percentage increase in the output gap
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causes of output gaps
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"changes in economy wide spending
(government can change this easily by changing its own spending)"
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Keynesian Model
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"decline in aggregate spending may cause output to fall below potential output
in the short run, firms meet demand for their products at a preset price"
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income-expenditure multiplier
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effect of a one-unit increase in autonomous expenditure on short-run equilibrium output
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contractionary policies
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government policy actions designed to reduce planned spending and output
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Board of Governors
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leaders of the Fed consisting of 14 members appointed by the president to staggered 14 year terms
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Federal Open Market Committee
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FOMC makes decisions regarding monetary policy
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banking panic
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situation in which news or rumors of the imminent bankruptcy of one or more banks leads bank depositors to rush to withdraw their funds
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deposit insurance
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"instituted by Congress after the depression
system in which the government guarantees that depositors will not lose any money even if their bank goes bankrupt (under 100,000)"
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federal funds rate
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the interest rate that commercial banks charge each other for very short-term loans
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increased interest rates lead to...
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"decline in consumptions spending
decline in planned investment spending
decline in PAE
increase in saving"
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things that affect the benefits of holding money
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"increases in real income or output (higher income=higher demand for money)
the price level (higher price level=higher demand for money)"
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discount window lending
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the lending of reserves by the Fed to commercial banks
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discount rate (or primary credit rate)
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the interest rate that the Fed charges commercial banks to borrow reserves
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reserve requirements
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set by the Fed, the minimum values of the ratio of bank deposits that commercial banks are allowed to maintain
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ways in which Fed can increase money supply and lower ew. nominal interest rate...
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"open market purchases
increase in discount window lending
decrease in interest rate paid on required reserves
reduction in reserve requirements"
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long-run equilibrium
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situation in which the AD and AS curves intersect at potential output Y*
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short run equilibrium
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situation where AD and AS curves intersect at a level of real GDP that is above or below potential
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AD curve
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"shows the amount of output consumers, firms, government, and customers abroad want to purchase at each price level, holding all other factors constant
increase in P (price level) eventually leads to decrease in PAE and decrease in output Y"
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Wealth Effect
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An increase in price level causes real household wealth to fall, which reduces planned consumption
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The Interest Rate Effect
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An increase in the price level results in higher money demand and a higher interest rate, causing both planned consumption and planned investment to fall
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The Exchange Rate Effect
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an increase in the price level causes the dollar to appreciate, which reduces net exports
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demand shocks
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"changes in planned spending that are not caused by changes in output or the price level
primary cause of aggregate demand shifts"
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to increase aggregate demand, government can...
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"increase government spending
cut taxes
increase money supply"
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aggregate supply curve (AS curve)
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a curve that shows the relationship between the amount of output firms want to produce and the price level
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why does the price level increase?
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an increase in the aggregate demand for goods and services will result in an increase in the amount of real GDP firms are willing to supply, and this increase in real GDP will be accompanied by an increase in the price level
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expected price level
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the price level expected when the economy is at potential output
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price shocks
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"changes in input prices that are not caused by changes in output or the price level
primary cause of aggregate supply shifts"
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AD-AS model for studying business cycle (5 steps)
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"show economy in long-run equilibrium
identify how AD and or AS curves are affected
Shift curves appropriately
Find economy's new short-run equilibrium
compare the new short-run equilibrium with initial long-run equilibrium to show how output and price level were affec…
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self-correcting property
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the fact that output gaps will not last indefinitely but will be closed by falling or rising prices
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Stabilization policy is helpful when...
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"recession is caused by negative demand shocks and costly when caused by negative price shocks
negative demand shocks caused Great Recession"
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Final Study Guide