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economic growth rate
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the annual percentage change of real GDP
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Real GDP per person
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real GDP divided by population.
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Aggregate production function
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shows how real GDP changes as the quantity of labor changes.
Increase in labor increases real GDP.
Increase in labor increases real GDP.
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Real Wage Rate
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the money wage rate divided by the price level
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Aggregate Labor Market
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Real Wage Rate on y axis
Labor units on x axis
Labor units on x axis
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what makes potential GDP grow
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growth in the supply of labor
growth in labor productivity
growth in labor productivity
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Growth in the supply of labor
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Average hours per worker
employment-to-population ratio
the working-age population growth
employment-to-population ratio
the working-age population growth
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Labor productivity
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quantity of real GDP produced by an hour of labor
= real GDP / Aggregate labor hours
= real GDP / Aggregate labor hours
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conditions for labor productivity growth
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physical capital growth
human capital growth
technological advances
human capital growth
technological advances
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physical capital growth
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accumulation of new capital increases capital per worker--> increases labor productivity
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human capital growth
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acquired through education, training
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technological advances
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discovery and application of new tech in production increases efficiency
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Classical growth theory
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growth of real GDP per person is temporary, if it rises too much it will fall back down
levels out at the subsistence level
levels out at the subsistence level
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Neoclassical growth theory
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real GDP per person grows because tech change encourages saving and investment, causing capital per hour of labor to grow.
Growth stops when technological change stops.
population growth is independent to real GDP and Real GDP growth rate.
Growth stops when technological change stops.
population growth is independent to real GDP and Real GDP growth rate.
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New Growth theory
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Real GDP per person grows because of choices that people make in pursuit of profit. Growth persists indefinitely
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Policies to achieve faster growth
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stimulate saving
stimulate research and development
Improve the quality of education
Provide aid to developing nations
encourage international trade
stimulate research and development
Improve the quality of education
Provide aid to developing nations
encourage international trade
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Financial Capital
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funds that firms use to buy physical capital
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Gross investment
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total amount spent on purchasing new capital and replacing old capital
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depreciation
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decrease in the quality of capital that results from wear and tear and obsolescence
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net investment
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=gross investment-depreciation
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Wealth
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the value of all the things that people own
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Saving
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the amount of income that is not paid in taxes or spent on consumption of goods and services
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Financial institutions
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a firm that operates on both sides of markets; they lend in one and borrow in another
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net worth
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total market value of what it has lent minus the market value of what it has borrowed
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insolvent
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when the net worth of an institution is negative
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illiquid
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cant be easily sold for cash
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market for loanable funds
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aggregate of all the individual financial markets
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funds that finance investment
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household savings (S)
Government surplus (T-G)
Borrowing from the rest of the world (M-X)
Government surplus (T-G)
Borrowing from the rest of the world (M-X)
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Nominal Interest Rate
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number of dollars that a borrower pays and lender receives in interest in a year.
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Real Interest Rate
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nominal interest rate adjusted to remove inflation.
=nominal interest rate-inflation rate.
=nominal interest rate-inflation rate.
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Demand for loanable funds
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the relationship between the quantity of loanable funds demanded and the real interest rate
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Changes in the demand for loanable funds
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if expected profit increases, greater amount of investment and greater demand for LF.
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The supply for loanable funds
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relationship between the quantity of loanable funds supplies and the real interest rate
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changes in the supply of LF
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increase in disposable income, decrease in expected future income, decrease in wealth, fall in default risk all increase saving and increase supply of LF
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Government and LF market
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government budget surplus increases supply of funds.
government budget deficit increases demand for funds.
government budget deficit increases demand for funds.
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Money
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any commodity or token that is generally acceptable as a means of payment
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means of payment
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method for settling a debt
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medium of exhange
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object that is generally accepted in exchange for goods and services
eliminates double coincidence of wants
eliminates double coincidence of wants
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Unit of account
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agreed measure for stating the prices of goods and services
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store of value
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money can be held for a time and later used in exchange for G&S
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Currency
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notes and coins held by households and firms
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Deposits
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considered money
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checks and credit cards
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NOT MONEY.
checks are instructions for the bank to transfer money
credit cards enable the holder to obtain a loan
checks are instructions for the bank to transfer money
credit cards enable the holder to obtain a loan
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depository institution
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a firm that takes deposits from households and firms and makes loans to other households and firms
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Reserves
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notes and coins in the vaults or a deposit at the FED for commercial banks
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Liquid assests
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the US govnt treasury bills and commercial bills
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securities
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longer-term US govnt bonds
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Loans
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commitments of fixed amounts of money for agreed periods of time
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Federal Reserve System (FED)
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the central bank of the US
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Central Bank
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the public authority that regulates a nations depository institutions and controls quantity of money
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Federal Funds rate
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the interest rate banks charge each other on overnight loans of reserves
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Open Market Operations
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purchase or sale of government securities by the FED from or to a commercial bank
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FED buys securities
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it pays for them with new reserves owed to the banks
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FED sells securities
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they are paid for with reserves held by banks
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Last resort loan
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fed stands ready to lend reserves to institutions short of reserves
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required reserve ratio
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minimum percentage of deposits that an institution must hold as reserves
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desired reserve ratio
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the ratio of the banks reserves to total deposits that the bank plans to hold
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currency drain ratio
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ratio of currency held by people to the deposits held by banks
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Excess reserves
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Actual Reserves-desired reserves
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Money Creation Process
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1. Increase in monetary base
2. FED buys securities from banks
3. FED pays with newly created bank reserves
4. Banks have more reserves but same amount of deposits
5. Quantity of money increases
2. FED buys securities from banks
3. FED pays with newly created bank reserves
4. Banks have more reserves but same amount of deposits
5. Quantity of money increases
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money multiplier
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the ratio of the change in quantity of money to the change in the monetary base
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Demand for money
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the relationship between the quantity of real money demanded and the nominal interest rate
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demand for money curve shift
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increase of real GDP shifts right
decrease in real GDP shifts left
decrease in real GDP shifts left
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Short-Run Equilibrium in the money market
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MS is straight up and down
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short-run effect of a change in the MS
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FED increases quantity of money, people hold more money than demanded--they buy bonds-->increased demand for bonds raises price and lowers interest rate
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Long-run Equilibrium in the money market
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nominal interest rate = real interest rate + expected inflation rate
Real GDP=potential GDP
Nothing real has changed.
Real GDP=potential GDP
Nothing real has changed.
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Quantity theory of money
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in the long-run, an increase in the quantity of money bring an equal percentage increase in the price level
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the velocity of circulation
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average number of times in a year a dollar is used to purchase goods and services in GDP
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inflation in the quantity theory of money
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= money growth rate - real GDP growth
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Long-run aggregate supply
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relationship between quantity of real GDP supplied and the price level when real GDP equals potential GDP
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Short-run Aggregate supply
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relationship between the quantity of real GDP supplied and the price level when the money wage rate, the prices of other resources, and potential GDP remain constant
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Aggregate supply and potential GDP
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potential GDP increases, LAS and SAS curves shift right, price level remains the same
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Changes in the money wage rate and Aggregate supply
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rise in Money Wage Rate decreases SAS, shifting leftward
LAS does not change
LAS does not change
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Aggregate Demand
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relationship between the quantity of real GDP demanded and the price level
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Wealth Effect
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rise in the price level leads to a decrease of real wealth
to restore wealth people increase saving and decrease spending-->Q of real GDP demanded decreases
to restore wealth people increase saving and decrease spending-->Q of real GDP demanded decreases
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Intertemporal Substitution effect
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rise in the price level = decrease in real value of money and raises interest rate--> people borrow less, Q of real GDP demanded decreases
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Changes to aggregate demand
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expectations
world economy
fiscal policy
world economy
fiscal policy
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Expectations effects on Aggregate demand:
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increases in expected future income increase people's consumption->increases AD
rise in expected inflation rate makes buying goods cheaper -> increases AD
increase in expected future profits boosts investment-> increases AD
rise in expected inflation rate makes buying goods cheaper -> increases AD
increase in expected future profits boosts investment-> increases AD
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Fiscal Policy's effects on Aggregate demand
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a tax cut increases disposable income. More disposable income increases consumption which increases AD
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monetary policy's effects on aggregate demand
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an increase in quantity of money increases buying power -> increases AD
cuts in interest rates increases expenditure -> increases AD
cuts in interest rates increases expenditure -> increases AD
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Short-run Macroeconomic equilibrium
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occurs when quantity of real GDP supplied at the point of intersection of the AD curve and SAS curve
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Long-run Macroeconomic Equilibrium
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occurs when real GDP equals potential GDP, when economy is on its LAS curve
Long-run Equilibrium occurs at the intersection of AD and LAS curves
Long-run Equilibrium occurs at the intersection of AD and LAS curves
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Economic Growth and inflation in the AS-AD model
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increase in potential GDP -> LAS curve shifts right
if the quantity of money grows faster than potential GDP, AD increases more than LAS, this leads to inflation (increase in price level)
if the quantity of money grows faster than potential GDP, AD increases more than LAS, this leads to inflation (increase in price level)
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above full-employment equilibrium
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part of the business cycle
equilibrium where Real GDP exceeds potential GDP
the difference between potential GDP and real GDP is called the inflationary gap
equilibrium where Real GDP exceeds potential GDP
the difference between potential GDP and real GDP is called the inflationary gap
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Full-employment equilibrium
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part of the business cycle
equilibrium where real GDP equals potential GDP
the amount that real GDP is less that potential GDP is called a recessionary gap
equilibrium where real GDP equals potential GDP
the amount that real GDP is less that potential GDP is called a recessionary gap
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below full-employment equilibrium
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part of the business cycle
equilibrium where potential GDP exceeds real GDP
equilibrium where potential GDP exceeds real GDP
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Classical view
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macro economist believes that the economy is self-regulating and always at full-employment
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new classical view
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view that the business cycle fluctuations are efficient responses of a well-functioning market economy
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Keynesian view
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left alone, the economy would rarely operate at full employment- fiscal and monetary policy is necessary to achieve that
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New Keynesian View
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not only is the money wage rate sticky but so are the prices of goods
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monetarist view
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economy is self-regulating and it normally operates at full employment IF monetary policy is not erratic and that pace of money growth is kept steady.
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Demand-Pull Inflation
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inflation that occurs when aggregate demand increases
(cut in interest rate, increase in quantity of money, increase in govt expenditure, increase in investments)
(cut in interest rate, increase in quantity of money, increase in govt expenditure, increase in investments)
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Money Wage Rate response to Demand-pull inflation
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money wage rate rises and shifts SAS curve leftward, price level rises and real GDP drops back to potential GDP
continued increase in AD can turn into a spiral of increasing inflation
continued increase in AD can turn into a spiral of increasing inflation
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Cost-Push Inflation
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inflation that starts with an increase in costs
(increase in the money wage rate, increase in the money price of raw materials)
(increase in the money wage rate, increase in the money price of raw materials)
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Aggregate demand response to cost-push inflation
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initial increase in costs creates a one-time rise in PL NOT INFLATION
however the FED will increase the quantity of money in response to return real GDP to potential GDP (regain full-employment)--> shifts AD right which causes inflation
however the FED will increase the quantity of money in response to return real GDP to potential GDP (regain full-employment)--> shifts AD right which causes inflation
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Stagflation
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combination of a rising price level and a decreasing real GDP
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Phillips curve
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shows the relationship between the inflation rate and unemployment rate
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Short-run phillips curve
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trade off between the inflation rate and the unemployment rate; holds the expected inflation rate and natural unemployment rate constant
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Long-run phillips curve
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the relationship between inflation and unemployment when the actual inflation rate equals the expected inflation rate
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Shift in natural unemployment rate and phillips curve
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a change in natural unemployment rate shifts both the long-run and short-run phillips curves
(increase in Natural unemployment shifts LRPC and SRPC to the right, maintains same inflation rate)
(increase in Natural unemployment shifts LRPC and SRPC to the right, maintains same inflation rate)
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mainstream business cycle theory
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Real GDP fluctuates around potential GDP because of fluctuations in AD
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Real Business Cycle Theory
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random fluctuations in productivity are the main source of economic fluctuations
(productivity fluctuations affect the LF market)
(in LF market, real interest rate drops, decreasing supply of labor--> leads employment and real wage rate to decrease which will fluctuate the inflation rate and the real GDP)
(productivity fluctuations affect the LF market)
(in LF market, real interest rate drops, decreasing supply of labor--> leads employment and real wage rate to decrease which will fluctuate the inflation rate and the real GDP)
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Federal Budget
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the annual statement of the federal govt's outlays and tax revenues
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fiscal policy
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using the federal budget to achieve macroeconomic objectives like full employment, sustained growth, and price level stability
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Supply-side effects of Fiscal policy
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Income Tax- supply of labor decreases because tax decreases the after-tax wage rate, drops .
when quantity of labor drops, potential GDP drops, decreasing AS as well
when quantity of labor drops, potential GDP drops, decreasing AS as well
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tax wedge
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gap created between the before-tax and after-tax rates
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Laffer curve
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relationship between the tax rate and the amount of tax revenue collected
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fiscal stimulus
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fiscal policy to increase production and employment
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Generational Accounting
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accounting system that measures the lifetime tax burden and benefits of each generation
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Fiscal imbalance
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present value of the gov'ts commitments to pay benefits minus the present value of its tax revenues
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automatic fiscal policy
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action triggered by the state of the economy with no government action
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discretionary fiscal policy
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action that is initiated by an act of Congress in response to the condition of the economy
Most often focused on changes to AD
Most often focused on changes to AD
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automatic changes in tax revenues
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an automatic fiscal policy
taxes depend on real GDP
when RGDP increases in expansion, tax rev increases
when RGDP decreases in recession, tax rev decreases
taxes depend on real GDP
when RGDP increases in expansion, tax rev increases
when RGDP decreases in recession, tax rev decreases
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Needs-Tested Spending
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an automatic fiscal policy
programs that pay benefits to qualified people and businesses
in expansion, unemployment falls, needs-tested spending decreases
in recession, unemployment rises, needs-tested spending increases
programs that pay benefits to qualified people and businesses
in expansion, unemployment falls, needs-tested spending decreases
in recession, unemployment rises, needs-tested spending increases
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