chapter 11 Flashcards
prior to the 1930s, what model was mostly used?
classical model
what is the classical model?
the idea that wages and prices adjusted to bring the economy to full employment
what raised some doubts about the classical model?
in 1933, unemployment rate in Canada was over 20%
what is the classical theory?
demand for goods adjusted to meet supply and to consume what is being produced
what is says law?
“supply creates its own demand” , classical theory
according to Keynes, can aggregate demand maintain full employment?
no, aggregate demand may be to low to maintain full employment
what is Keynes law/ Keynes general theory?
demand creates its own supply
what is the assumption of the IS/LM model?
prices are sticky/ ridged in short run but adjust in long run
when was the interpretation of Keynes ideas first developed?
in 1937 by John hicks
what is the IS, in IS-LM model?
the model of loanable funds
in the short run in the IS-LM model, is output determined by production function?
no it is not
what is the LM, in IS-LM model?
liquidity and money
in the IS-LM model, what does demand for real money balances depend on?
it depends on output (income) and the interest rate
according to the Keynesian cross, in the short run what is total income determined by?
by the desire to spend by households, businesses and government (planned expenditure)
Y=C+I+G
what do recessions and depressions result from?
in adequate spending by on the various actors in the economy
what is actual expenditure?
amounts households, firms and government actually spend on goods and services
what does actual expenditure equate to?
GDP (Y)
what is planned spending (PE)?
amount households, firms and government would like to spend on goods and services
does actual expenditure have to be equal with planned spending?
no
what are the 3 factors of planned expenditure?
PE= C(Y-T) + I(r) + G
what does the slope of the planned expenditure curve (Keynesian cross) represent?
the marginal propensity to consume (MPC)
when there is a gap between the planned expenditure line and the actually expenditure (GDP), what might cause that?
firms build up unplanned inventory
what might firms do to reduce the gap between the planned expenditure curve and the GDP curve?
firms my cut production till they are even
when there is a change in government spending, how does that impact the kenysian cross?
the planned expenditure curve will shift up due to the increase in planned expenditure, and it will cause the GDP to increase by change (government spending X govt spending multiplier)
what is the government spending multiplier?
the amount that change in government spending impacts the GDP
what is the formula for the government spending multiplier?
change in GDP= (1/1-MPC) X change in G
if the MPC is 0.75, how much will a change in government spending impact the GDP?
1/1-MPC
1/1-0.75
1/0.25
govt spending multiplier=4
the GDP (Y) will change by, change in govt spending times 4
how does an increase in taxes impact the GDP?
change in taxes reduces disposable income which causes a decrease in consumption by change in T X tax multiplier
what is the tax multiplier?
the amount that a change in taxes impacts the GDP (Y)
what is the tax multiplier formula?
change in GDP = -MPC/1-MPC
if the MPC is 0.75
and there is an increase in taxes, how much will that impact the GDP (Y)?
tax multiplier= -0.75/ 1-0.75
-0.75/0.25
tax multiplier= -3
it will decrease the economy by change in taxes times -3
how will a change in investment impact the GDP(Y)?
it will change the GDP by change in investment times the investment multiplier
what is the investment multiplier?
the amount of change in GDP resulting from a change in investment
what is the investment multiplier formula?
1/1-MPC times change in investment
what relationship does the IS curve show?
the relationship between the real interest rate and the GDP and that interest rate gives equilibrium in the goods market
where is the IS curve derived from?
the kynesian cross and the market for loanable funds
how will an increase in investment impact planned expenditure?
it will increase the planned expenditure
why, when there is a change in I, there is a larger increase in Y than in I?
due to the investment multiplier
when the Keynesian cross is in equilibrium, what does Y=?
Y=PE
what does it mean if PE<Y?
expenditure is less than income and firms are acquiring unplanned inventories causing firms to reduce output to reduce Y and bring them to equilibrium
what does it mean if PE>Y?
expenditure is greater than income and firms are experiencing unplanned depletion of inventories, firms would increase output to increase Y
what is the IS curve?
the relationship between the real interest rate and national income by combining information from 2 previous graphs (market for loanable funds and Keynesian cross)
what shifts the IS curve?
changes in fiscal policy, because the interest rate stays the same but Y changes
how will holding more money impact the money market?
it will cause the curve to shift up
if r is to high how will that impact the money market?
supply of real money balances will exceed demand, people will try to adjust buy buying interest bearing assets, increased demand for assets reduce interest rate bringing it to equilibrium
how will a decrease in money supply impact the money market?
it will cause the money supply to decrease (shift left) and increase interest rate
how does an increase of national income impact the money market?
it will cause the demand curve to shift upwards and increase the real interest rate
what does the LM curve show?
the combinations of interest rate and level of income that are consistent with equilibrium in the market for real money balances
