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ECON 311: TEST 3
Equation of Exchange:
_*_=_*_
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MV=PY
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Velocity
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average number of times per year a $ is spent
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Keynes believes there is a ________ relationship between ________ ______ and ________ demand
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negative
interest rates
speculative
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Keynes believes there is a ________ relationship between ____________ _______ and __________
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interest rates and velocity
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Real Money Balances = __ / _
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MD / P
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Keynes:
MD / P = _(_,_)
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f(i,y)
i - int rate (-)
y - real income (+)
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As the real interest rate increases, the demand for real money balance _________
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decreases
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As the real income increases the demand for real money balances _________
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increases |
AVG Money Balance = ___+___ / _
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end + beg / 2
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V = _*_ / _
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P*Y / M
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Fisher Theory
M: 1
RtoIR: 1
V: 1
Form: 2
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M: Transactional
RtoIR: None
V: Constant
Form: MD = k*fy, k=1/V
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Keynes Theory
M: 3
RtoIR: 2
V: 2
Form: 1
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M: 1. transactional
2. precautionary
3. speculative
RtoIR: 1. ⇑IR ⇒ ⇓ MD/P
2. ⇓ IR ⇒ ⇑ MD/P
V: 1. ⇑ IR ⇒ ⇑ V
2. ⇓ IR ⇒ ⇓ V
Form: MD/P=f(i,y)
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Baumol - Tobin Theory
M: 1
RtoIR: 2
V: 2
Form: 0
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M: Transactional
RtoIR: 1. ⇑ IR ⇒ ⇓ MD/P
2. ⇓ IR ⇒ ⇑ MD/P
V: 1. ⇑ IR ⇒ ⇑ V
2. ⇓ IR ⇒ ⇓ V
Form: None
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Friedman Theory
M: 2
RtoIR: 1
V: 1
Form: 2
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M: 1. Transactional
2. Asset Demand
RtoIR: Very little impact mainly driven by YP
V: Fluctuate but change is predictable
Form: 1. MD/P = f(YP)
2. MD/P = f(YP,[(rb-rm),(re-rm),(πe-rm)]
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End Result of Baulmol - Tobin Model
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the opportunity cost of holding money for transaction purposes is FORGONE INTEREST. The greater the opportunity cost the smaller the real money balances
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Transactional Motive
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people hold money to carry out ordinary transactions
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Precautionary Motive
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people hold money to carry out unexpected transactions
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Speculative Motive
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people allocate wealth between money and "other financial assets"; mainly bonds.
Interest matters
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Why is velocity unpredictable?
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because of changes in interest rates
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Friedman's Modern Quantity Theory of Money (2)
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1. Wealth: an incentive in wealth leads to a less proportional increase in money demand
2. The expected return on other assets relative to the expected return on money
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1. YP -
2. rm -
3. rb -
4. re -
5. πe -
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1. permanent income
2. expected return on money
3. expected return on bonds
4. expected return on stocks
5. expected inflation - expected return on durable goods
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In Friedman's Modern Quantity Theory of Money, Velocity is ____________
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predictable
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Y = _+_+_+__
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C+I+G+NX
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Y = YAD_______ ______ = _______ ______
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aggregate supply = aggregate demand
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Consumption Function:
_ = _+(___*__)
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C = a+(mpc*YD)
C - consumption spending
a - autonomous consumption (spending when income = 0)
mpc - marginal propensity to consume (mpc + mps = 1)
YD - disposable income (after tax income)
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What do the parts of the consumption function represent? (Think Y = mx + b)
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C - y variable
a - y intercept
mpc - slope
YD - x variable
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Investment (4)
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1. Private domestic investment spending
2. Bared on "Planned Investment"
3. Fixed investment in physical capital
4. Inventory investment
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Fixed investment in physical Capital (4)
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1. land
2. property
3. securities
4. equipment
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Inventory Investment (3)
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1. raw materials and component parts
2. work in process
3. finished goods
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Draw and explain outputs H (3), G (5), and I (5) of Consumption Function Graph
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H: 1. point A 2. Y = YAD 3. actual inventory investment = planned inventory investment
G: 1. point C = production 2. point B = sold 3. # units sold > # units produced 4. Inventory depletion 5. increase production in future to fix
I: 1. point F = production 2. point B = sold 3. # units produced > # units sold 4. unplanned inventory accumulation 5. Decrease production in future to fix
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Y = _+_+_+__+___*_
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a+I+G+NX+mpc*y
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Simple expenditures multiplier = _ / (_-___)
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1 / (1-mpc)
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ΔY =
__ * (_ / _-___)
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ΔA*(1 / 1-mpc)
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J gets $3000/m and spends it a a constant rate over the month (1m=30d).
O1: Get paid $3000 to start month
O2: J can buy treas. bills that pays 6%/yr (.5%/m). He buys a $1500 treas. bill on the 1st day of each month. $100/d and after 15 days he runs out of money and has to sell the treas bill.
Which O is better?
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If $3.75 of interest earned > transaction cost of buying and selling treas. bill, then O2 is better
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IS Curve (3)
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1. Investment & Savings curve
2. deals with the goods/services market
3. derived from Y = C+I+G+NX
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Draw graph where every point on an IS curve represents equilibrium in the goods market
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draw
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If the point lies inside of the IS curve then...?
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shortage in the goods market
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If the point lies on the IS curve then...?
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equilibrium in the goods market
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If the point lies outside of the IS curve then...?
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surplus in the goods market
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LM Curve (3)
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1. Liquidity and money curve
2. money market
3. derived off money market
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Draw graph where every point on the LM curve represents an equilibrium in the money market
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draw
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If the point lies inside the LM curve then...?
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surplus of money
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If the point lies on the LM curve then...?
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equilibrium
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If the point lies outside the LM curve then...?
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shortage of money
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Interest rates and bond prices have an __________ relationship
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indirect
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________ policy affects the IS curve
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fiscal
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________ policy affects the LM curve
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monetary
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The steeper the LM curve the _____ change, and the flatter the LM curve the _____ change
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less more
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Taxes and Government spending affect which curve?
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IS
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