Eco part 2 Flashcards
Q: State the Keynesian equilibrium condition for injections and leakages.
S+T+M=I+G+X.
Leakages = investments
Injections: These are the additions to the economy, like investment, government spending, and exports.
Leakages: These are the withdrawals from the economy, like savings, taxes, and imports.
Q: Define the marginal propensity to consume (MPC).
A: The fraction of additional disposable income spent on consumption:
Q: If MPC = 0.8, what is the value of the Keynesian multiplier?
k= 1/ 1 - 0.8 =5.
Q: What does the 45° line in the Keynesian cross diagram represent?
A: All points where aggregate expenditure equals aggregate income (AD = Y).
Q: Explain the paradox of thrift.
A: Increased saving reduces consumption, leading to lower aggregate demand and income, potentially worsening economic downturns.
Q: What is the formula for the accelerator effect?
A: α = ΔI/ΔY, linking investment to changes in output.
Q: How do cost-push inflation and demand-pull inflation differ?
A: Cost-push arises from supply shocks (e.g., rising oil prices), while demand-pull is due to excess aggregate demand.
Q: What is the natural rate of unemployment?
A: The unemployment rate when the labor market is in equilibrium, consisting of frictional and structural unemployment.
Q: List three components of the balance of payments.
A: Current account, capital account, and changes in foreign reserves.
Q: How does a devaluation affect exports and imports?
A: Exports become cheaper for foreigners, and imports become more expensive, improving the trade balance (if elastic).
Q: What does the Phillips curve illustrate?
A: A short-run inverse relationship between inflation and unemployment.
Q: Define real exchange rate.
RER=NER× P foreign / P domestic, adjusting nominal rates for price differences.
Q: What is hysteresis in unemployment?
A: Long-term unemployment causing skill erosion, reducing employability and creating persistent joblessness.
Q: What is the quantity theory of money equation?
MV = PQ, where M = money supply, V = velocity,P = price level, Q = real output.
Q: Explain stagflation.
A: High inflation combined with stagnant economic growth and high unemployment (e.g., 1970s oil crises).
Q: What is fiscal policy?
A: Government use of spending and taxation to influence aggregate demand and economic activity.
Q: What is the Laffer curve?
A: Illustrates the relationship between tax rates and tax revenue, suggesting excessive rates reduce revenue.
Q: How does the Solow growth model explain steady-state growth?
A: Long-run growth depends on exogenous factors like population growth and technological progress, not savings.
Q: What is endogenous growth theory?
A: Emphasizes internal factors (e.g., R&D, education) driving long-term growth, unlike exogenous models.
Q: Calculate APC if consumption = 500 and disposableincome = 600.
APC= 500 / 600 = 0.83.
Q: What is the output gap?
Difference between actual GDP and potential GDP ( Y - Y* ).
Q: How does a trade deficit relate to fiscal deficits?
M−X=(I−S)+(G−T). A fiscal deficit (G>T) can worsen the trade deficit.
Q: What is vertical equity in taxation?
A: Higher-income earners pay a larger fraction of income as tax (progressive taxation).
Q: Define disposable income.
A: Yd = Y−T, income available after taxes for consumption/saving.
Q: What causes structural unemployment?
A: Mismatch between workers’ skills/location and job requirements (e.g., automation, industry decline).
Q: Why is investment the most volatile component of GDP?
A: Influenced by interest rates, expectations, and accelerator effects tied to output changes.
Q: What is crowding out in fiscal policy?
A: Government borrowing raises interest rates, reducing private investment.
Q: How does adaptive expectations affect inflation?
A: People base future inflation expectations on past trends, leading to self-fulfilling price spirals.
Q: What is the Salter-Swan diagram used for?
A: Analyzing internal balance (full employment) and external balance (BOP equilibrium) using exchange rates and absorption.
What is Pareto efficiency?
Resource allocation where no one can be made better off without making someone worse off, achieved when price equals marginal cost (P=MC).
