5 Flashcards
regarding output determination, in the LR, output (Y) is determined by…
aggregate supply
Y = A f(K,L,H,N)
regarding output determination, in the SR, output (Y) is determined by…
aggregate demand
Y = C + I + G + CA
what is the definition of aggregate demand (D)?
it is the total amount of G&S that individuals and gvts are willing to buy
D = C + I + G + CA
concerning aggregate demand, what is the determinant of consumption expenditures?
disposable income Yd = Y-T
more disposable income = more consumption
what is the principle behind the marginal propensity to consume?
it is the proportion of an increase in disposable income is spent on consumption of G&S (the rest goes to savings)
MPC is less than one: when Yd (Y-T) increases by 1%, C increases by less than one
concerning aggregate demand, what are the determinants of the current account?
- disposable income (Yd = Y-T)
- real exchange rate (q = E P*/P)
concerning D, how does an increase or decrease of disposable income affects the current account?
- increase of disposable income = more expenditures on imports = decrease of CA
- decrease of disposable income = increase of CA
concerning D, how does an increase or decrease of the real exchange rate affects the current account?
- increase of real exchange rate = increase of CA
- decrease of real exchange rate = decrease of CA
how does an increase in disposable income increase aggregate demand (D)?
Y ↑ = Yd ↑ = Im ↑ = CA ↓ = AD ↓
BUT
Y ↑ = Yd ↑ = C ↑ = AD ↑ by more
Explain how does an increase in the real exchange rate affect exports and imports?
When the real exchange rate increases, domestic products are cheaper relative to foreign products. Due to this, exports increase as foreigners demand more of our exports. The change in imports is ambiguous because fewer units of imports are purchased (the volume effect), but each foreign unit is now more expensive (the value effect). Remember: exports and imports are measured in terms of domestic output, i.e. dollar value, not volume of units. However, we often assume that the volume effect outweighs the value effect, so that imports decrease when the real exchange rate rises.
what is the aggregate demand (D) function?
D (EP*/P, Y-T, I, G)
what can be said about the aggregate demand function slope?
it is less than one because of the marginal propensity to consume: when disposable income increase
what equilibrium does the aggregate demand function help to determine?
the short run equilibrium for aggregate demand and output
what causes the aggregate demand to shift?
- change in the marginal propensity to consume
- change in taxes
- change in investment
- change in gvt spending
- change in the real exchange rate due to E, P* or P
what is the SR effect on aggregate demand of a currency depreciation?
because foreign G&S become relatively more expensive, demand for domestic G&S increases = aggregate demand shifts upward = output increases
an increase in the MPC, C(Y-T), causes the aggregate demand to shift…
upward
an increase in taxes causes aggregate demand to shift…
downward
an increase in gvt spending causes aggregate demand to shift…
upward
a appreciation of the real exchange rate causes aggregate demand to shift…
downward
what curve determines the SR equilibrium between output and the exchange rate?
DD curve
what is the DD curve and how is it obtained?
the DD curve is the relationship between the exchange rate and short-run output. it is obtained by deriving the aggregate demand function
the DD schedule shows all the combinations of … and … at which the …. market is in equilibrium
the DD schedule shows all the combinations of Y and E at which the output market is in equilibrium
the DD curve slopes upward: an exchange rate …. cause D & Y to …
the DD curve slopes upward: an exchange rate depreciation cause D & Y to rise
T or F: for a given output and exchange rate, the factors shifting the D curve also shift the DD curve
True!
- taxes
- investment
- gvt spengind
- MPC
- preferences about domestic and foreign goods (relative price P*/P)
what are the shifters of the DD curve?
- change in gvt spending (↑ G = ↑ DD)
- change in taxes (↓ T = ↑ DD)
- change in investment (↑ I = ↑ DD)
- change in MPC (↑ MPC = ↑ DD)
- change in relative prices (↑ P* or ↓ P = ↑ DD)
what are the 2 assets markets we studied before?
- the equilibrium in the foreign exchange market = interest rate parity condition
R=R*+(Ee-E/E)
- the equilibrium in the money market = real MS = real MD
MS/P = L(R,Y)
what is the key implication for the foreign exchange market and the money market to be in equilibrium?
a rise in income (Y) leads to an exchange rate appreciation & a fall in income must be accompanied by a depreciation
↑ Y = ↑ MD = ↑ R = ↓ E
↓ Y = ↓ MD = ↓ R = ↑E
illustrate the effect of an increase in gvt spending on D and DD schedule
D shifts upward and DD shifts to the right
what does the AA schedule illustrates?
it is the combinations of Y and E for which the foreign exchange market and the money market are in equilibrium
what are the factors that cause the AA schedule to shift upward or downward?
- change in the MS
- change in the expected exchange rate (Ee)
- change in prices
- change in R*
- change in real Md
how does an increase of the money supply affect the AA schedule
↑ MS = ↓ R = ↑ E = ↑ AA
how does an increase in the expected exchange rate affect the AA schedule?
↑ Ee = ↑ E = ↑ AA
how does an increase in prices affect the AA schedule?
↑ P = ↓ MS = ↑ R = ↓E = ↓AA
what can be said about the short-run equilibrium that occurs at the intersection of the DD and AA curves?
- output markets are in equilibrium on the DD curve
- asset markets (foreign exchange and money market) are in equilibrium on the AA curve
the nominal exchange rate and the level of output that happen at the short-run equilibrium that occurs at the intersection of the DD and AA curves are such that…
The nominal exchange rate and the level of output are such that:
- The output market is in equilibrium:
Y = D
- The foreign exchange market is in equilibrium: the interest parity holds such that
R = R + (Ee-E/E)
- The money market is in equilibrium:
Ms/P = L (Y;R)
