question
fundamental macro equation
answer
Y = C + I + G + NX
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personal consumption expenditures
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- the expenditures of households for durable and nondurable consumer goods and services
- doesn't vary much even during periods of recession
- doesn't vary much even during periods of recession
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current disposable income
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income after taxes are paid and government transfers are received
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consumption function
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the relationship between consumption spending and disposable income
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Marginal Propensity to Consume (MPC)
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- the slope of the consumption function: the amount by which consumption spending changes when disposable income changes
- change in spending / change in current income (GDP)
- change in spending / change in current income (GDP)
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Marginal Propensity to Save (MPS)
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- the increase in household savings when disposable income rises by $1
- 1-MPC
- 1-MPC
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expected future disposable income
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(Y-T+TR)^e
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determinants of consumption
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- current disposable income
- household wealth
- real interest rate
- price level
- household wealth
- real interest rate
- price level
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household wealth
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The value of assets - including property, shares, savings and pension fund assets - minus liabilities
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what does investment include?
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- plants and equipment (nonresidential fixed investment)
- housing (residential fixed investment)
- change in inventories
- housing (residential fixed investment)
- change in inventories
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inventories
answer
- finished goods that haven't been sold yet
- raw materials that haven't been used yet
- goods that aren't finished yet and are still in the middle of production
- raw materials that haven't been used yet
- goods that aren't finished yet and are still in the middle of production
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why investment is an important part of aggregate expenditure
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- it is the most volatile component
- it is vital to economic growth (change in capital)
- it is vital to economic growth (change in capital)
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determinants of investment
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- expectations of future profitability
- taxes (corporate income tax, investment tax credits)
- cash flow
- real interest rate
- taxes (corporate income tax, investment tax credits)
- cash flow
- real interest rate
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financing alternatives
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- borrow the money (bank loans, bonds)
- sell ownership shares
- use own retained earnings
- sell ownership shares
- use own retained earnings
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nominal exchange rate (E)
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- the price of one currency in terms of another currency
- unit of foreign currency / unit of domestic currency
- unit of foreign currency / unit of domestic currency
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appreciation
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- An increase in the value of a currency / exchange rate
- goods become more expensive for foreign buyers to purchase
- goods become more expensive for foreign buyers to purchase
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depreciation
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- decrease in the value of a currency / exchange rate
- goods become cheaper for foreign buyers to purchase
- goods become cheaper for foreign buyers to purchase
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demand for $US comes from
answer
- Foreign firms and households wanting to buy U.S. goods and services
- Foreign firms and households wanting to invest in U.S. physical or financial assets
- Currency traders believing the value of the $US will rise
- Foreign firms and households wanting to invest in U.S. physical or financial assets
- Currency traders believing the value of the $US will rise
question
supply for $US comes from
answer
firms, households and speculators want to obtain foreign currency and pay with US dollars
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what happens to $US when the exchange rate is too high?
answer
- surplus of $US
- rate will depreciate
- rate will depreciate
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changes in supply and demand for foreign exchange might result from
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- change in demand for US-produced goods and services relative to foreign ones
- change in desire to invest in US relative to other countries
- change in expectations of currency traders about likely future value of $ relative to foreign currencies
- change in desire to invest in US relative to other countries
- change in expectations of currency traders about likely future value of $ relative to foreign currencies
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what causes E to fluctuate?
answer
- 95-98% of international currency transaction volume results from speculation and worldwide trade in assets
- real interest rate
- real interest rate
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impact of real interest rate on E
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- when it increases in the US relative to the rest of the world
- the demand for US-denominated assets goes up
- demand for dollars goes up
- price of a dollar goes up
- the demand for US-denominated assets goes up
- demand for dollars goes up
- price of a dollar goes up
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real exchange rate (e)
answer
- the price of domestic goods in terms of foreign goods
- (PDom x E) / PFor
- (PDom x E) / PFor
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Purchasing Power Parity (PPP)
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- the theory that, adjusting for E, the same goods should cost the same wherever in the world they are sold
- if true, e=1 always
- does not actually hold in most contexts (Big Mac Index)
- if true, e=1 always
- does not actually hold in most contexts (Big Mac Index)
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Big Mac Index
answer
- Tool for calculating purchasing power parity that compares prices of a Big Mac throughout the world
- found that PPP does not hold in most cases
- found that PPP does not hold in most cases
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if e>1
answer
- E is too high
- foreign currency is undervalued relative to the domestic currency
- foreign currency is undervalued relative to the domestic currency
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if e<1
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- E is too low
- foreign currency is overvalued relative to the domestic currency
- foreign currency is overvalued relative to the domestic currency
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2 reasons PPP does not always hold
answer
- many goods can't be easily traded and price differences can't be arbitraged away
- foreign and domestic goods are not perfect substitutes; price differences reflect differences in tastes
- foreign and domestic goods are not perfect substitutes; price differences reflect differences in tastes
question
if 2 countries have different inflation rates, ____
answer
E will change over time
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net exports measures
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the imbalance in a country's trade in goods and services
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determinants of exports
answer
- real exchange rate
- GDP of our trading partners
- tastes and preferences of foreign buyers for our goods and services
- trade policies
- GDP of our trading partners
- tastes and preferences of foreign buyers for our goods and services
- trade policies
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real exchange rate and exports
answer
- when e goes up, X goes down
- when e goes down, X goes up
- when e goes down, X goes up
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determinants of imports
answer
- real exchange rate
- domestic GDP
- domestic tastes and preferences for foreign goods
- trade policies
- domestic GDP
- domestic tastes and preferences for foreign goods
- trade policies
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real exchange rate and imports
answer
- when e goes up, IM goes up
- when e goes down, IM goes down
- when e goes down, IM goes down
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real interest rate increase and net exports
answer
- increase in r leads to increased demand for US-denominated assets
- demand for $ increases
- E and e increase
- X decrease and IM increase
- NX decreases
- demand for $ increases
- E and e increase
- X decrease and IM increase
- NX decreases
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aggregate demand curve
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- relates the price level to aggregate expenditure on the economy's goods and services
- aggregate expenditure denotes a point on the curve
- aggregate expenditure denotes a point on the curve
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why does the AD curve slope down?
answer
1. wealth effect
2. interest rate effect
3. international trade effect
2. interest rate effect
3. international trade effect
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wealth effect
answer
- price level increases
- purchasing power of household wealth decreases
- thus, consumption spending decreases and AE decreases
- purchasing power of household wealth decreases
- thus, consumption spending decreases and AE decreases
question
interest rate effect
answer
- when P increases, then r increases, increasing incentive to save and costs to borrow --> consumption spending decreases and AE decreases
- when P decreases, then r decreases, lowering incentive to save and costs to borrow --> consumption spending increases and AE increases
- when P decreases, then r decreases, lowering incentive to save and costs to borrow --> consumption spending increases and AE increases
question
international trade effect
answer
- when PDom increases, e increases
- NX decreases
- AE decreases
- NX decreases
- AE decreases
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what shifts the AD curve?
answer
- government policies (monetary, fiscal)
- changes in expectations of households and firms
- changes in foreign variables
- changes in expectations of households and firms
- changes in foreign variables
question
monetary policy
answer
- policies that affect interest rates by manipulating the monetary supply
- Federal Reserve
- when r increases, AD shifts left
- when r decreases, AD shifts right
- Federal Reserve
- when r increases, AD shifts left
- when r decreases, AD shifts right
question
fiscal policy
answer
- policy that determines how the economy is managed as a result of government spending and taxes
- Congress, White House, Treasury Department
- Congress, White House, Treasury Department
question
when E increases
answer
- e increases
- NX decreases
- AD shifts left
- NX decreases
- AD shifts left
question
when E decreases
answer
- e decreases
- NX increases
- AD shifts right
- NX increases
- AD shifts right
question
when YDom increases
answer
- imports increase
- NX decreases
- AD shifts left
- NX decreases
- AD shifts left
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when YDom decreases
answer
- imports decrease
- NX increase
- AD shifts right
- NX increase
- AD shifts right
question
when YFor increases
answer
- X increases
- NX increases
- AD shifts right
- NX increases
- AD shifts right
question
when YFor decreases
answer
- X decreases
- NX decreases
- AD shifts left
- NX decreases
- AD shifts left
question
aggregate supply curve
answer
shows the relationship between the aggregate price level and the quantity of goods and services that firms are ready, willing and able to supply
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what determines an economy's capacity to produce in the long run?
answer
- capital stock
- labor
- technology
- labor
- technology
question
T/F: in the long run, price level has nothing to do with growth
answer
true
question
Long Run Aggregate Supply (LRAS)
answer
- The level of output to which an economy will always return in the long run
- The LRAS curve intersects the horizontal axis at the full employment or potential level of output
- same Y at every price level
- The LRAS curve intersects the horizontal axis at the full employment or potential level of output
- same Y at every price level
question
Short Run Aggregate Supply (SRAS)
answer
- a curve that shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms
- slope indicates degree of price flexibility
- slope indicates degree of price flexibility
question
SRAS with completely fixed (sticky) prices
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firms cannot change prices so all goods and services must be supplied at the same P
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SRAS with completely flexible prices
answer
- contracts make some wages and prices sticky
- firms are often slow to adjust wages
- menu costs make some prices sticky
- firms are often slow to adjust wages
- menu costs make some prices sticky
question
why does the SRAS curve slope up?
answer
- increases in the labor force and capital stock
- technological change
- technological change
question
what causes both the LRAS and SRAS curves to shift?
answer
- expected changes in the future price level (e.g. charging higher prices due to expected higher costs)
- adjustments of workers and firms to errors in past expectations about the price level
- unexpected changes in the price of an important natural resource
- adjustments of workers and firms to errors in past expectations about the price level
- unexpected changes in the price of an important natural resource
question
what causes only the SRAS curve to shift?
answer
- An unexpected decrease in the availability of a key resource that temporarily decreases productivity
- every level of GDP now associated with higher price level
- every level of GDP now associated with higher price level
question
negative supply shock
answer
- An unexpected increase in the availability of a key resource that temporarily increases productivity
- firms can produce more efficiently and lower prices
- firms can produce more efficiently and lower prices
question
positive supply shock
answer
- the economy is in this when the point of short-run macroeconomic equilibrium is on the long-run aggregate supply curve
- economy is producing everything it should based on normal factors
- unemployment at natural rate
- based on stable price level and meeting potential GDP
- economy is producing everything it should based on normal factors
- unemployment at natural rate
- based on stable price level and meeting potential GDP
question
long-run macroeconomic equilibrium
answer
1. GDP is above its long-run level
2. unemployment is below the natural rate
3. prices are higher (inflation)
- SRAS shifts left to get back to LRAS
- new price level is higher, but stable
2. unemployment is below the natural rate
3. prices are higher (inflation)
- SRAS shifts left to get back to LRAS
- new price level is higher, but stable
question
inflationary gap
answer
1. short-run GDP below potential GDP
2. unemployment above natural rate
3. decrease in price level
- SRAS shifts right to get back to LRAS
- new price level is lower and stable
2. unemployment above natural rate
3. decrease in price level
- SRAS shifts right to get back to LRAS
- new price level is lower and stable
question
recessionary gap
answer
- led to a recessionary gap at the same time as rising inflation
- if the govt did nothing, businesses would lower prices and workers would work for lower wages until SRAS shifts down to get back to LRAS
- if the govt did nothing, businesses would lower prices and workers would work for lower wages until SRAS shifts down to get back to LRAS
question
1970's: negative supply shock caused by OPEC oil embargo
answer
- characteristics of an inflationary gap (benefits) without actual inflation (harm)
- over time, businesses raise prices due to high demand and workers begin to demand higher wages, shifting SRAS up
- over time, businesses raise prices due to high demand and workers begin to demand higher wages, shifting SRAS up
question
1990's: positive supply shock
answer
a curve that shows the short-run trade-off between inflation and unemployment
question
Phillips Curve
answer
- low unemployment w/ high inflation
- low inflation w/ high unemployment
- anything in between
- low inflation w/ high unemployment
- anything in between
question
initially, the PC appeared to offer policymakers a menu of choices
answer
- in 1968, Friedman and Phelps argued the tradeoff was temporary and wouldn't hold
- natural rate hypothesis --> unemployment eventually returns to natural rate regardless of inflation
- since LRAS is vertical, it must also be vertical in the LR
- natural rate hypothesis --> unemployment eventually returns to natural rate regardless of inflation
- since LRAS is vertical, it must also be vertical in the LR
question
development of the vertical long-run PC
answer
change in the natural unemployment rate
question
what can shift the long run PC?
answer
- a measure of how much people expect the price level to change
- bridges the gap between long-run and short-run PCs
- along any given short-run PC, expected inflation is the same
- bridges the gap between long-run and short-run PCs
- along any given short-run PC, expected inflation is the same
question
expected inflation
answer
where the long-run PC intersects the short-run PC
question
where does actual inflation = expected inflation?
answer
- making inflation greater than expected
- only temporary
- only temporary
question
how can monetary policy reduce the unemployment rate below the natural rate?
answer
natural unemployment rate
question
nonaccelerating inflation rate of unemployment (NAIRU)
answer
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