ECON midterm

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  1. demand-GDP
    inventory investment
  2. assumption in short run
    • price is fixed
    • ie. firms are willing to supply any amount of goods
  3. Consumption is a function of...
    disposable income
  4. Why are G&T exogenous?
    Governments do not behave with the same regularity as consumers or firms.

    Macroeconomists must think about the implications of alternative spending and tax decisions of the government.
  5. Difference btw GDP and total demand for goods
    Inventory investment; because it is not consumed it is not part of the demand
  6. *Components in GDP, eg. C and IM may offset each other and result in no net change in GDP
  7. Autonomous spending is positive when...negative when...
    • Government is running a balanced budget or having budget deficit;
    • very large budget surplus
  8. Formula of Z
    Z=(autonomous spending)+c1Y
  9. *Any change in autonomous spending will change output by more than one for one
  10. The multiplier effect/amplification effect comes from
    • demand Z↑
    • production Y↑
    • income↑
    • consumption↑
    • hence Y↑>initial shift in demand
  11. Y=income/production;
    • Demand
    • expenditure
    • spending
  12. Interpreting the multiplier
    The sum of all successive increase in production
  13. How Long Does It Take for Output to Adjust?
    assume production responds to demand instantaneously!

    assume consumption responds to changes in disposable income instantaneously.
  14. Deriving IS relationships
    • no govt
    • Y=Z
    • Y=C+Saving
    • Z=C+I
    • I=Saving

    • verify I=saving
    • with govt
    • Y=C+I+G
    • I=Y-C-G
    • private saving=Y-T-C
    • public saving=T-G
    • national saving=Y-C-G
    • hence I=national saving
  15. private saving equation
  16. Equilibrium IS equation
    I=-c0+(1-c1)(Y-T)+(T-G)(ie the public saving)
  17. Explain how diseqm leads to inventory investment
    Originally the firm produces 100 units and it is the equilibrium output, now it decides to produce 200 units, according to Z=c1Y+autonomous spending, change in demand equals c1(0.5)*100=50, total demand=150, 50 units becomes inventory investment
  18. what is the paradox of saving
    as people attempt to save more, the result is both a decline in output and unchanged saving IN THE SHORT RUN
  19. mechanism behind paradox of saving-I=S perspective
    • s=-c0+MPS(disposable income)
    • when consumer wants to save more, c0 ↓
    • 1)-c0 ↑, s ↑
    • 2)consumption ↓, Z ↓, by eqm, Y↓, S↓
  20. The government is not omnipotent because
    •  Changing government spending or taxes is not always easy .
    •  The responses of consumption, investment, imports, etc, are hard to assess with much certainty.
    •  Anticipations are likely to matter .
    •  Achieving a given level of output can come with unpleasant side effects.
    •  Budget deficits and public debt may have adverse implications in the long run.
  21. mechanism behind paradox of saving-Y=Z perspective
    • S=Y-T-C
    • Y=C+I+G(Y=Z)
    • hence S=I+G-T
    • consumer's decision to save more cannot affect I, G, T
    • S does not change
  22. how to calculate GDP deflator
    nominal GDP/real GDP(specific base year)
  23. calculate inflation rate
    • Pt: GDP deflator of t
    • P(t-1): GDP deflator of t-1
    • inflation rate=Pt-Pt-1/Pt-1
  24. under what condition will chained type GDP and fixed based year GDP give different numbers
    • produce more than one good
    • otherwise due to the different weights of goods, the estimate is not accurate
  25. problems with fixed based year
    • overest. growth of years after base year and underest growth of years before base year
    • frequent revisions
  26. how to calculate real GDP for 2001 in chained dollars
    • matrix: base years dollars as column; years'productions as row
    • use column results: production growth rate for both years
    • avg production growth rate
    • 2000 index:1; 2001 index=1+avg rate
    • 2001 GDP in chained=nominal GDP in 2000*2001 index
  27. how to calculate eqm output and demand
    • Y, Yd, C, multiplier, autonomous spending
    • output: mutliplier
    • demand: C+I+G
  28. why is tax called automatic stabilizer when T=t0+t1Y
    • multiplier=(1-c1+c1t1)
    • autonomous spending↑, Y↑, T↑, lessen the ↑in Y
    • economy responds less to changes in autonomous spending than in the case where T is independent of Y
  29. suppose t depends on Y, if autonomous spending ↓, why is balanced budget requirement destabilizing?
    • Y↓ and T↓
    • to balance budget, ↓G
    • Y further ↓
  30. suppose I=b0+b1Y, if b0 ↑, what is the ↑ in investment?
    (b0↑)+ b1*Y↑
  31. if investment is exogenous(given), saving is
  32. variables which affect demand for money
    NOMINAL income $Y, +

    i, (-)
  33. why Interest rate has a negative effect on money demand
    • as interest rate increase,
    • return of bonds increase,
    • people put more wealth on bonds instead of money
  34. equilibrium condition in the financial market(LM relation) and explain
    MS=$Y L(i)
  35. What does M(money supply) depends on
    monetary policy of the central bank
  36. shifting variables of demand for money
  37. effect of buying bonds on bond price and interest rate and implications
    • decrease interest rate,
    • increase bond price
  38. effect of changing the RRR
    increase M
  39. a decision of the central bank to lower the interest rate is equivalent to...
    increasing money supply
  40. monetary policy instruments for the central bank to change the money supply
    interest rate(federal funds rate, discount rate)

    required reserve ratio

    open market operations
  41. shifting variables of LM curve
  42. deriving the LM curve
    • increase Y
    • Md curve shifts right
    • eqm interest rate increase
    • (one point of LM)
  43. investment depends on
    level of sales(Y, +)

    interest rate(i, -)
  44. why investment depends on Y
    • as output changes, 
    • demand changes, 
    • firms change investment in order to keep up capacity with demand
  45. why ↓M changes output
    i↑, investment↓, demand↓, output↓
  46. why interest rate has a negative effect on investment
    • high interest rate,
    • cost of borrowing money increase
    • investment decrease
  47. what are the measures of fiscal expansion
    • cut tax
    • increase government spending
  48. why is Z an increasing function of Y?
    • Y increase, 
    • C and I increase,
    • demand for goods increase
  49. why is ZZ flatter than 45deg line?
    • increase in the output will not lead to an one-for-one increase in demand
    • (by a factor of MPC)
  50. shifting variables of IS curve
    ZZ(demand for goods)
  51. Deriving the IS curve
    • increase I
    • ZZ curve shift down(through decrease in investment)
    • eqm output decrease
    • (obtain one point on IS curve)
  52. exogenous variables in the ISLM model
    fiscal policy and monetary policy
  53. how fiscal expansion change ISLM model
    increases the demand in goods market

    shift IS curve to the right
  54. how monetary expansion change ISLM model
    increase the money supply

    shift LM curve to the right
  55. is monetary expansion more investment friendly than fiscal expansion?

    fiscal expansion:Y&I increase

    monetary expansion: Y increase and i decrease
  56. changes in autonomous spending has what effect on I
  57. if investment is independent of interest rate
    • IS curve is a vertical line
    • fixed ouput
  58. Decrease in money demand has equivalent effect as
    Increase in money supply
  59. factors that shift money demand
    Use of atm: left

    Worry about bank failure: right

    decrease in price level: right
  60. Looking at the effect of deficit reduction on investment from investment-saving relationship

    T-G↑, I↑


    Y&C↓, Y↓>C↓(MPC), S↓

  61. If Y is a variable in C and I
    Z is an increasing function of Y
  62. Let M/P=d1Y-d2i, slope of the LM curve…
  63. direct effect(of output on demand) of the multiplier
    captured by c1+b1

    horizontal shift of the IS curve
  64. indirect effect of the multiplier
    captured by b2d1/d

  65. what is crowding out and its implication
    increase in output due to shift in IS curve-eqm output

    effect of fiscal policy on interest rate limits the ability of fiscal policy to influence output
  66. larger multiplier mean the sensitivity of consumption and investment to output is
  67. Effectiveness of fiscal policy depends on
  68. crowing out(con’t)-why and how the slope of LM curve affect effectiveness of fiscal policy(interest rate)
    • G increase,
    • Y increase
    • money demand increase
    • interest rate increase

    amount of increase in interest rate depends on slope of LM curve

    • d1/d2 is smaller
    • the flatter LM curve
    • the less increase in interest rate
    • less crowding out
  69. Implication of balanced budget change
    follow the direction of G because the effect of G is always greater than that of T
  70. if there is fiscal contraction, what variables must change?
    Y, C&i
  71. if consumer confidence change, what variables must change?
    C, Y, i
  72. if money supply change, what variables must change?
    • i, I, Y, C
    • (no change if investment is independent on interest rate)
  73. definition of real money supply
    stock of money measured in terms of goods
  74. dynamic assumption of ISLM model...
    based on the assumption, changing M will lead to... and changing fiscal policy will lead to...
    • economy always on LM, only moves slowly to IS
    • immediate change in i and no initial change in Y
    • gradual change in i and gradual change in Y
  75. with IS↑ and LM↓, under what condition will I be ambiguous?
    • i must ↑
    • if output ↓, I is lower
    • output↑, I is ambiguous
  76. slope and intercept of the IS curve
    • -(1-c1-b1)/b2; 
    • c0-c1T+b0+G
  77. investment is very sensitive to interest rate
    • a flatter IS slope
    • a less effective fiscal policy(small multiplier)
  78. increasing M in higher MPC countries leads to...
    • since flatter IS
    • larger increase in output and smaller decrease in i
  79. eqm Y ISLM combined: multliplier
  80. eqm Y ISLM combined: autonomous spending
  81. why banks keep reserve?
    • subject to requirements
    • people withdraw money
    • depositors write checks
  82. calculate RRR
    bank reserves/checkable deposits
  83. how banks create checkable deposits
    making loans on credit
  84. US 2001 recession
    cause: ↓ in I

    policy: ficsal and monetary expansion

    outcome: offset part of the  ↓ in Y
  85. arguements for PRC to cut RRR
    • affirm:
    • encourage banks  to lend to small enterprise after credit crisis
    • retain investment(western counterpart)
    • high i and high RRR, a lot of room
    • boost property price

    • against:
    • labour market holding up
    • inflation
Card Set
ECON midterm
ECON midterm
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