Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Macroeconomic Theory > Chapter 4 > Flashcards

Chapter 4 Flashcards

1
Q

In the context of Consumption and Saving:

What is the formula of the Income Expenditure Identity?

A

Y = C + I + G + NX

The G is given while the net exports is 0 (closed economy)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Desired Consumption and Desired Saving are decisions about

A

How much to consume and how much to save

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

Desired Consumption and Desired Saving:

National Level of Desired Consumption (C^d) is

A

The aggregate quantity of goods and services that households want to consume

Given income and other factors that determine households’ economic opportunities.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Desired Consumption and Desired Saving:

National Level of Desired Consumption (C^d) is obtained by

A

Adding up the desired consumption of all households

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

Desired Consumption and Desired Saving:

National Level of Desired saving (S^d) is

A

Level of national saving that occurs when aggregate consumption is at its desired level

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Desired Consumption and Desired Saving:

The fromula of National Level of Desired saving (S^d) is

A

S^d = Y – C^d - G

S = Y + NFP – C - G NFP = 0 (closed economy) so technically
(S = Y – C - G) = (S^d = Y – C^d - G)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

Consumption and Saving Decision of an Individual:

Given r, the consumer could either

r ~ interest

A
  • Current consumption
  • Future consumption (Current Saving)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Smooth Pattern of consumption involves

A

Creating a balance between spending and saving

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Consumption and Saving Decision of an Individual:

Factors that affect Desired national saving

A
  • Current Income
  • Expected Future Income
  • Wealth
  • Real Interest rate
  • Fiscal policy

In all cases the G is given except with Fiscal Policy similarly r is given in all cases except with Real interest rate

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Effect of Changes in Current Income

(i.e. increase in current income – current bonus)

A
  • (C^d) will rise by the Marginal Propensity to Consume (MPC)
  • (S^d) will rise by the Marginal Propensity to Save (MPS)
  • Increase in Aggregate Income (output) (Y)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

MPC is

A

change in consumption due to one unit change in
income.

Similarly MPS is change in saving due to one unit change in income.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

Effect of Changes in Current Income

Increase in current income would result in a more proportional increase in

A

Output(Y) than Desired consumption

C^d increase with the value of the MPC only while output with MPC & MPS

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

An increase in future income – next year bonus

The consumption-smoothing motive would result in

A

Individuals increasing their current desired consumption (Cd)

This increase is in anticipation for higher future income

Given that current income is constant

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

An increase in current desired consumption is matched by

A

a reduction in current desired saving (S^d)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Effect of Changes in Expected Future Income:

An increase in future income will result in

What will happen in terms of output?

A

Increase in expected aggregate income (output) (Y) increases C^d
and reduces S^d

Where Y is constant

The opposite happens in case of reduction in expected future income

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

Effect of Changes in Wealth:

Increase in Financial assets lead to

Change in wealth has similar effect to that of expected future income

A

an increase in current desired consumption (Cd)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

Given current income:

Increase in current desired consumption
reduces

A

current desired saving (S^d)

↑Wealth, Y is constant → ↑Cd and ↓Sd

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

How would a reduction in wealth affect C^d and S^d?

A

decreases desired consumption (C^d)

↓Wealth, Y is constant → ↓Cd and ↑Sd

Given current income, decrease in C^d is matched by an increase in current desired saving (S^d).

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

Effect of Changes in Real Interest Rate (Increase):

2 effects arises when real interest rate increase

A
  • Substitution Effect
  • Income efffect
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

Increase in Real interest Rate:

Explain the Subtitution Effect in terms of consumption

A

Tendency to reduce current desired consumption and increase future consumption

Increase current desired saving due to increase in r

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

Increase in real interest rate:

Explain Income effect

A

Reflects change in current desired
consumption when higher r makes consumer richer or poorer

Depends on whether consumer is a saver or borrower.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

Income Effect of Increase in Real Interest Rate:

How does it depend whether the consumer is a borrower or a lender

A

Borrower experiences a decrease in wealth while lender experience an increase in wealth

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

Due to Income Effect of Increase in Real Interest Rate:

A saver expriences an increase in wealth therefore

What ahppens in terms of c^d and s^d

A
  • Increase current desired consumption
  • Reduce current desired
    saving
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

Due to Income Effect of Increase in Real Interest Rate:

A Borrower expriences a decrease in wealth therefore

What ahppens in terms of c^d and s^d

A
  • Decrease current desired consumption
  • Increase current desired
    saving (reduces dissaving)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q

Due to an increase in Real interest rates:

A saver could either Increase desire saving or decrease desire saving, but Why?

A

Due to the substitution and income effect

When real interest rate increase, one can feel wealthier thus increasing desired consumption (income effect) while other might increase desired saving due to the higher intreset (substitution)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
26
Q

Due to an increase in Real interest rates:

For whom has the two Effects in the same direction

Substitution and Income effect

A

Borrower

When real interest rate increase, borrower can feel less wealthy thus decreasing desired consumption (income effect) similarly borrower will decrease desired saving due to the higher intreset (substitution)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
27
Q

Taxes and Real Return to Saving:

Expected real after-tax interest rate reflects

A

the purchasing power of saving

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
28
Q

The formula of After-tax real interest rate

A

r_a-t= (1 – t)i – π^e

Given nominal interest rate and inflation, a reduction in tax rate increase real interest rate

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
29
Q

Fiscal Policy:

Changes in Fiscal
Policy (Y given) is experienced because of a change in

A

Either G changes (temporarily) or G is fixed and taxes changes

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
30
Q

Changes in Fiscal Policy (Y given):

If G changes
(Temporarily), the impact on S^d and C^d are

A
  • Affects S^d directly
  • Affects C^d depending on mean of financing change in G
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
31
Q

Fisical Policy:

Show how a Temporary Increase in G would result in a reduction in S^d

A

↓S^d = Y – Cd - ↑G

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
32
Q

In context of Fiscal Policy, show how:

A temporary increase in G has a Direct Effect on Cd and Indirect Effect on Sd

A
  • Increase in G could be funded by a raise in taxes therefore reducing current income thus reducing C^d
  • Increases in G could be funded by borrowing (future taxes) therefore Reduces expected future income and hence ↓Cd

For a given current level of output (Y), a temporary
increase in G reduces both C^d and S^d

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
33
Q

According to Ricardian Equivalence Proposition:

Why a Lump Sum Tax Cut has No effect on Cd and Sd

A

It Increases Current Income and reduces future income (borrowing or future taxes)

With no change in current or planned G, Ricardian Equivalence Proposition expects a tax cut to have no effect on Cd and Sd
Otherwise, a tax cut increases Cd and reduces Sd

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
34
Q

Definition of investment:

The two types of Investments

A
  • Fixed Investment
  • Inventory Investment
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
35
Q

Definition of Investment:

Types of Fixed Investment

A
  • Business Fixed Investment
  • Residntial Investment
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
36
Q

Definition of Investment:

The decision to invest implies a trade-off between

A

present (current resources) and future (higher capacity and profits in the future)

37
Q

Definition of Investment:

It is important to track investments because

A
  • Investment spending fluctuates sharply during business cycles.
  • Investment plays a crucial role in determining the long-run productive capacity of the economy.
38
Q

Investment:

The Desired Capital Stock

A

It is the amount of capital that allows the firm to maximize its
profit (earn the largest expected profit).

39
Q

Desired Capital Stock:

What is the cost of Additional Unit of Capital

A

User Cost of Capital (uc)

40
Q

Desired Capital Stock:

What is the Benefit of additional unit of Capital

A

Expected Future
Marginal Product of Capital (MPK^f)

The Benefit of increasing today by one unit of capital

41
Q

The Desired Capital Stock:

The User cost of capital

A

Expected real cost of using a unit of capital for a specified period of time.

42
Q

The Desired Capital Stock:

The User Cost of Capital formula

A

uc = rpK + dpK = (r + d)pK

rpK is the Interest cost of using capital and dpk is the depreciation cost on capital

43
Q

Calculate The User Cost of Capital: Example:

Kyle’s Bakery Co produces specialty cookies. The manager,
Kyle, wants to invest in a new solar-powered oven.
➢ The new oven’s price measured in real (base-year) dollars is $100.
➢ No maintenance or energy cost.
➢ The oven depreciates (its value fall) by 10% per year.
➢ Kyle can borrow from the bank or buy government bond at
expected real interest rate of 8% per year.

A

The user cost of capital is the sum of depreciation cost and
interest cost.
➢ Depreciation cost (dpK) = d* pK = 0.10100 = $10.
➢ Interest cost (rpK) = r pK = 0.08*100 = $8.
➢ User cost of capital = dpK + rpK = $10+$8 = $18.

44
Q

Desired a capital stock:

How to determine the desired capital stock

A

MPKf = uc

45
Q

Changes in the Desired Capital Stock:

Anything that changes uc causes the uc curve to

A

Shift

46
Q

Changes in the Desired Capital Stock:

What changes the uc

A
  • Changes in r
  • Changes in pk
  • Changes in d

All these changes causes the uc curve to shift

47
Q

Changes in the Desired Capital Stock:

A Fall in interest rates causes the uc curve to

A

Shift downwards

Indicating that it lowers uc

48
Q

Changes in the Desired Capital Stock:

A downward shift in the uc curve causes the desired capital stock to

A

Increase

49
Q

Changes in the Desired Capital Stock:

In our example (Kyle’s Bakery) assumes that a new type of cookie dough is invented that requires less baking time and hence increases MPKf by 12.5% at each K. What happens to the MPKf curve?

A

Shifts Upward

The new equilibrium point with uc curve is further to the right indicating an increase in desired capital stock.

50
Q

Changes in desired capital stock:

Taxes and the Desired Capital Stock

What is the formula

A

(1 – t) MPK^f = uc

(1-t) is the tax rate on revenues where
(1 – t) MPK^f as a whole is After-tax future marginal product of capital

51
Q

Changes in Fisical Policy can happen because of

A
  • A change in G (temporarily)
  • A change in Taxes
52
Q

Fisical Policy:

Changes in G affect

A
  • Desired Saving directly
  • Desired Consumption depending on mean of financing change in G
53
Q

A change in Taxes While G is fixed will affect

A
  • Current Income or expected Future Income therefore affecting Desired consumption
54
Q

Fiscal Policy: Temporary Increase in G

How it has a direct effect on Desired Saving

A

Reduces Desired Saving
↓Sd = Y – Cd- ↑G

55
Q

Fiscal Policy: I) Temporary Increase in G

How it has Direct Effect on Cd & Indirect Effect on Sd

A
  • Funded by raising
    current T hence Reducing current income and hence ↓Cd
  • Funded by borrowing (future taxes) therefore Reducing expected future income and
    hence ↓Cd
56
Q

For a given current level of output (Y), a temporary increase in G reduces

A

Both Cd and Sd

57
Q

What is the effect of:

Lump Sum Tax Cut
(G Given)

A
  • Increases Current Income thus reduces future income (borrowing or future taxes)
  • Increase after tax Current Income Increases Cd and Reduces Sd
58
Q

Lump Sum Tax Cut :

What does the Ricardian Equivalence Proposition state?

A

With no change in current or planned G, Ricardian Equivalence
Proposition expects a tax cut to have no effect on Cd and Sd
. Otherwise, a tax cut increases Cd and reduces Sd

59
Q

Definition of Investment:

Investment is divided into

A
  • Fixed Investment
    1. Business Fixed Investment
    2. Resdential Investment
  • Inventory Investment
    1. Change in Inventory
60
Q

If the Taxes and the Desired Capital Stock formula is
(1 – t) MPK^f = uc
then in terms of MPK the Formula is

A

MPKf = uc / (1 – t)
Where uc equals
(r + d)pK
Therefore
= (r + d)pK/ (1 – t)

61
Q

- Changes in the Desired Capital Stock:

What will happen to the desired capital stock if t increased??

A

Increase in t raises the tax-adjusted user cost of capital and reduces K.

tax-adjusted user cost of capital is uc / (1 – t)

62
Q

Taxes and the Desired Capital Stock:

Why In reality, taxes are much more complicated?

A
  • Taxes are paid on profits not revenues.
  • Depreciation allowance affects tax payments.
  • The presence of investment tax credit.
63
Q

Effective tax rate

A

A single measure of tax burden on capital.

64
Q

How Changes in tax law that raises the effective tax rate affect the tax-adjusted user cost of capital

A

Raises the effective tax rate… increases
the tax-adjusted user cost of capital and decreases K.

65
Q

Changes in the capital Stock over the year can happen because of

A
  • Purchase of new Capital goods
  • Depreciation
66
Q

Net Investment is equal to

A

Gross Investment - Depreciation

Net Investmentt = Gross investmentt – depreciationt
= I_t – dK_t

67
Q

Net Investment as a concept of Changes in the capital Stock over the year, its Formula is

A

Net Investment= K_t+1 – K_t

68
Q

If Net Investment = Kt+1– Kt
and also Net Investment = Gross investment_t – depreciation_t
= I_t – dK_t then I_t equals

A

Kt+1 – Kt = I_t – dK_t
I_t = Kt+1 – Kt + dK_t

69
Q

From the Desired Capital Stock to Investment:

If by the end of year t, the firm acquired the desired level of
capital (K*) then I_t equals

A

It = K* – Kt + dKt

70
Q

According to this formula
I_t = (K* – Kt) + dKt
What each part of this formula denote?

A
  • Desired net increase in K
    (K*- Kt)
  • Replace depreciated capital (dKt)
71
Q

Desired net increase in K
(K*- Kt) include

A

Taxes, interest rates, MPK^f

72
Q

Replacing depreciated capital (dKt) involves

A

Depreciation rate and initial K

73
Q

From the Desired Capital Stock to Investment

Why investment needed to reach the desired capital stock may be spread out over several years

A

Since Some capital can be constructed easily, but other capital may take years to put in place

74
Q

Investment in Inventories and Housing:

Inventory investment equals

A

The increase in firms’ inventories of unsold goods, unfinished goods or raw materials.

75
Q

Investment in Inventories and Housing:

Residential investment is

A

The construction of housing

76
Q

How firms decide whether to increase inventory by one unit or build one apartment

A

By comparing between MPKf and uc.

77
Q

Example for Inventory Investment:

A

Car dealer decided to increase number of cars…. expected increase in sales commission from selling extra car vs. depreciation and interest.

78
Q

Example for residential investment

A

Building apartment …
potential revenues from rent vs. depreciation and interest.

79
Q

Good Market equilibrium occurs when

A

Aggregate quantity of goods demanded equals the aggregate quantity of goods supplied.

80
Q

Good Market
Equilibrium
Condition

A

Y = Cd + Id + G

Y is the Quantity of Goods Supplied (Output) and (Cd + Id + G) is thr Aggregate demand for goods (Spending)

81
Q

How to deduce that
Sd = Id is the Good market equilibrium

A

Y = Cd + Id + G
Y - Cd – G = Id
Y - Cd – G = Sd
then Sd=Id

Sd is the fundSupplied by savers and Id is Fund Demanded by investors

82
Q

The Saving- Investment Diagram

A

It shows amount of funds supplied by savers
and amount of funds demanded by investors

Where r is on the vertical axis while I is on the Horizontal Axis Where adjustments in r bring the market into equilibrium

83
Q

The Factors that would shift S^d curve

A
  1. Current Output
  2. Expected Future Output
  3. Wealth
  4. Fisical Policy
84
Q

How a temporary increase in G affect the Goods Market Equilibrium

A

It causes an upper Shift in the Saving Curve therefore the new equilibrium point is at a higher interest rate and a lower desired Investment and Saving

85
Q

What is the Crowding effect

A

When increased government purchases cause investment to decline, economists say that investment has been crowded out. The crowding out of investment by increased government purchases occurs, in effect, because the government is using more real resources, some of which would otherwise have gone into investment.

86
Q

Goods Market Equilibrium:

When there is a temporary increase in G, desired Investment falls. This is often refered as

A

Crowding out

87
Q

Goods Market Equilibrium:

When there is a temporary increase in G, desired Saving falls causing an increase in

A

Real interest rate

88
Q

Goods Market Equilibrium:

What are the factors that shift Id curve??

A
  • Taxes
  • Depreciation
  • MPK^f
89
Q

Goods Market Equilibrium

What Happens to the Good market euilibrium when there is new technological Invention

A

Shifts of the Investment Curve to the right therefore the new equilibrium is at a higher real interest rate and National Savimg and desired investment increase

Macroeconomic Theory (8 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions