1. Economics Flashcards
Discretionary fiscal policy lags
Recognition Lag: policymakers take time to recognize the problem
Action Lag: discussions, vote, political process
Impact Lag: time between measure implementation and its results
Crowd out effect (fiscal policy)
Expansionary Government spending may crowd out private investments
Fiscal Multiplier, Balance Budget Mutiplier
Fiscal Multiplier: 1 / 1 - [MPC* (1-t)]
BBM: Tax Increase * MPC * Fiscal Multiplier
Net Effect in DA: Fiscal Multiplier - BBM
Price Elasticity of Demand
- %ΔQ / %ΔP
- (ΔQ / ΔP) * (Po / Qo), where
ΔQ/ΔP = linear coef
Normal / Inferior Goods
Normal goods: ↑ Income = ↑ Consumption
Inferior goods: ↑ Income = ↓ Consumption
Complement Goods (A and B)
↑ Price (A) = ↑ Price (B)
↑ Price (A) = ↓ Consumption (B)
Own-price elasticity signal
Positive if demand is upward-sloping (↑ Price = ↑ Consumption)
Negative if demand is downward-sloping (↑ Price = ↓ Consumption)
Giffen Good
Rice in China (↓ Price = ↓ Consumption), given that a drop in price wil give room for consumer to spend in other goods
Income Effect (-) > Substitution Effect (+)
Upward sloping demand
Veblen Good
Gucci bag (↑ Price = ↑ Consumption), only for some individuals at some prices
If Price ↑, Income Effect and Substitution still reduces overall consumption
Cross-Price Elasticity
- Find Q = ax + b
- Ensure that x is the cross-price you want to check
- Apply the formula of elasticity
Substitution effect
Always positive (↓ Price = ↑ Consumption)
Income effect
Positive if a normal good
Negative if an inferior good
Law of Diminishing Marginal Returns
Additional output reduces as input workers increase up to a point
Operate / Shutdown / Breakeven in Perfect Market Competition
AVC < P < ATC = Operate
P < AVC < ATC = Shutdown in SR
P = MC = ATC = Breakeven
Monetarist Formula
mv = py
GDP deflator
Real GDP = Nominal / Deflator
Fundamental Relationship (Savings, Investment, Fiscal Balance, Trade Balance)
(G - T) = (S-I) - (X-M)
Gata si Xama
Production Function
- Y = A * f ( L, K)
- (Y/L) = A * f (K/L)
where
A = total factor productivity
Potential GDP
GDP* = Hours Worked * Labor Productivity
GDP Growth
GDP Growth = Growth Labor Force + Growth Productivity
Neoclassical school
Productivity gains may push LRAS (paredão)
Keynesian school
Demand shifts = f (Expectations business cycle)
Wages are downward sticky
Government should spend or low interest rates
New Keynesian school
Wages and other input prices are also downward sticky (hard to lower)
Laysperes Index
Constant goods basket
Hedonic adjustment
Adjust index for increases in quality
Fisher Index
Geometric mean between Laysperes and Paasche
Paasche Index
Adjust index for consumption weights within the basket
Creation of Money Formula
Money Created = New Deposit / Reserve Requirement
If New Deposits = 100 and Reserve Req. = 0.25
Money Created = 100 / 0.25 = 400
Money Multiplier
Money Multiplier = 1 / Reserve Req.
If New Deposits = 100 and Reserve Req. = 0.25
Money Multiplier = 1 / 0.25 = 4
Monetary Transmission Mechanisms
- Bank’s short term ratings
- Prices (bonds, equity)
- Consumer expectations
- Domestic currency
Neutral Interest Rate (formula and definition)
Neutral Interest Rate = GDP Growth + Inflation Target
Neutral Rate is the interest rate that keeps inflation @ target.
Rate > Neutral means contraction
Rate < Neutral means expansion
Fiscal Multiplier (formula and definition)
Fiscal Multiplier = 1 / [1 - MPC*(1-t)]
It means that if G = +100 and Fiscal Multiplier = 2.5, the increase in AD = +250
↑ MPC = ↑ Fiscal Multiplier
↑ T = ↓ Fiscal Multiplier
Balance Budget Multiplier (formula and definition)
BBM = 100MPCFiscal Multiplier
- In order to balance the budget to spend more, Govt raises taxes.
- BBM is used to calculate net effect of G and T in Aggregate Demand
↑ T = ↓ Demand
Fisher Effect
Nominal Interest Rate = Real Rate + Expected Inflation Rate
GDP v. GNP
GNP is the production by a country’s citizens
GDP is the production within the country’s borders
Comparative Advantage
It measures the lower opportunity costs
Ricardian Model (Trade) v. Heckscher Ohlin
Ricardo: One factor of production: labor
Heckscher Ohlin: redistribution of wealth is problematic. Owners of capital will gain more; Owners of labor will gain less.
Trade: Tariffs
- Act over Imports (M)
- Domestic producers gain
- Foreign producers lose
- Govt gains Taxes
Trade: Quotas
- Act over Imports (M)
- Domestic producers gain
- Consumers lose from an increase in Prices
- If govt collects full value of the license sold, it works as a tariff
- Free Trade Areas
- Customs Union
- Common Market
- Economic Union
- Free Trade Area: No taxes for all
- Customs Union: lower taxes for all
- Common Market: remove barriers to X / M
- Economic Union: unify labor, capital goods, export of goods and services and adopt set of trade restrictions with members outside the group
Current Account (definition)
Flows of Goods/Services
CC = (X - M ) + Transf. Unilaterais
Capital Account
Capital Transfers and Acquisition of Non-produced and Non-Financial Assets
- Fixed Assets
- Debt forgiveness
- Sale of Patents/Copyrights/Trademarks
Financial Account
- Gold
- FX reserves abroad
- IMF SDR
- Foreign-owned assets within the country
- Think of the Central Bank
Objectives of capital flow restrictions
- Reduce volatility of asset prices
- Maintain fixed rates
- Keep domestic rates low
- Protect local industry
Base Currency v. Price Currency (concept)
- 4 USD / EUR
- USD is the price currency (numerator)
- EUR is the base currency (denominator)
Real Exchange Rate (concept and formula)
Real Exchange Rate = Nominal * (CPI base / CPI price)
- Order: “bp” = basis point / base over price
- Adjusted for the CPI difference between countries
Forward Rate (concept and formula)
Forward = Spot BRL / USD * (CPI USD / CPI BRL)
- Forward rate is the nominal rate * increase in foreign country’s CPI in relation to our prices (local)
- If Spot is “Price / Base”, then multiply by (CPI base / price)
Exchange Rate Depreciation % (concept)
You will only speak in terms of the denominator of the currency exchange rate
Ex.: 1.5 USD / EUR -> 1.2 USD / EUR
a. It expresses EUR in terms of dollars
b. EUR depreciated by [(1.5/1.2)-1] %
c. To get USD movement, invert Spot Rate to EUR / USD and calculate new % change
Cross Rate (concept)
a. MXN / AUD = (MXN / USD) * (USD / AUD)
b. Cancel USD from the pairs and get the 3rd pair
- It is possible to get a pair from two different pairs
Non-arbitrage condition for Forward Exchange Rate (formula and concept)
Forward / Spot = (1 + i price currency) / (1 + i base currency)
- Forward over Spot
- Order (formula): P / B
- Order (spot): P / B
The only difference between spot and forward refers to the difference between countrie’s interest rates. Otherwise, carry trade would be possible
Forward Rate Exchange (i) v. Non-Arbitrage Condition (ii)
(i) Forward Exchange Rate: adjusts for CPI “base / price”
Formula = BRL / USD * ( 1 + CPI USD) / (1+ CPI BRL)
- Used to calculate 90-day fwd
(ii) Non-arbitrage Forward Exchange Rate: adjusts for investment increase in each country (interest rate)
Forward / Spot = (1 + i price) / (1 + i base)
- Used to calculate non-arbitrage price of currency
Marshall-Lerner Condition (formula and concept)
Wxports * Elasticity(x) + Wimports * (ElasticityM - 1) > 0
- FX rate affects trade balance based in the basket of consumption (weight) and elasticity-price of demand for X and M
- If elasticity of X/M is high, it will be affected by FX movements
- In this case, currency depreciation leads to improvements in trade balance
- Remember that elasticity is high if Imports are non-essential goods. This makes the case for reducing deficits via depreciation.
To satisfy the Marshall-Lerner condition when M demand elasticity is 0, X demand elasticity must be larger than the ratio of M to X in the trade balance. This is necessary for trade surplus to occur.
Inclusion in the GDP:
a. Transfer Payments
b. Owner-occupied housing
c. Government Services
a. Not. Medicaire / Medicate are money allocation, not necessarily produced in current year
b. Yes. Service flowing from house to occupant, whether they are owners or not
c. Yes. Service flowing from consumer to government.
Total Factor Productivity (concept and formula)
Total factor productivity represents output growth in excess of that resulting from the growth in labor and capital.
Y = A * f (K, L)
Long-Term Sustainable Growth
Total Hours = Labor Force * Avg Output per Worker
Sources are:
- Increase in labor force
- Increase in physical capital
- Increase in technology
You cannot achieve long-term growth by only increasing physical capital / worker due to diminishing returns (40 PCs / 30 workers)
Which is the meaning of an increase of real exchange rate in USD/EUR?
↑ Real FX Rate = ↑ Purchase power of the base currency (denominator) in price currency (numerator)
By itself, a Real FX Rate does not indicate the directions or degrees of change in either the nominal exchange rate or the inflation difference. The 3% may come from inflation or nominal value (speculation, for example).
Conventional Fixed Peg (concept)
A conventional fixed peg allows for a small degree of fluctuation around the target exchange rate
Currency Board (concept)
The monetary authority will exchange its currency for USD at 1:1 ratio. Many businesses in the Islands will accept USD but this is not transaction.
Example: HKMA (Hong Kong)
Reducing Trade Deficit (concept)
a. Depends on elasticity of X and M
b. Luxury goods have higher inelasticity
c. Other goods are less impacted
To satisfy the Marshall-Lerner condition when M demand elasticity is 0, X demand elasticity must be larger than the ratio of M to X in the trade balance. This is necessary for trade surplus to occur.
