ECON 102 Final Flashcards

Question

Measurement Methods

Answer 1

Every country will compare the calculations of all 3 methods to find discrepancies & make adjustments/corrections to around the same value 1. Value Added 2. Income Approach 3. Total Expenditure

Answer 2

**Sum of Firm Payments for Factors of Production** Add the values of all final g+s produced in the economy. Intermediate g+s not included to not overestimate/double count as they’re values are aggregated in the final price. Government collect info from every firm, find input resources & revenue to calculate intermediate cost **Equation:** Payments to the firm’s factors of production = sales value - intermediate g+s value ex. $2+$(5-2)+$(10-5)+$(15-10)=15

Answer 3

**Sum of income from Factors of Production** Total value of outputs in the economy is equal to total factor income earned by households from firms in the economy (factor payments) & income earned by federal government from production (non-factor payments); ideally if we add (gross) wages, rents, interests & profits that should add up to the value of g+s produced within the economy * Don’t Include: inputs, used goods, financial assets, import spending, non market transactions, negative externality **Eqn**: GDP = Wages + Interest + Rents + Dividends + Non-Factor Payments (indirect tax + capital depreciation)

Answer 4

Eqn: GDP= C + I + G + NX g+s produced & bought within the economy (adjustments are required to factor in trade), by adding the expenditures on domestically produced final g+s in the economy **Consumption Expenditure (C)** * Households’ purchase of new goods & services * Imputed rents for self-owned homes (value of owner-occupied housing) * Newly built homes not included **Investment Expenditure (I)** Plants & Equipment, not inputs Newly built residential & non-residential structures Inventory adjustments: cost for storage for supply as safeguards ex. Prod-100 Sold-90 Storage-20+10->30 = GDP+10 ex. Prod-100 Sold-110 Storage-20-10->10 = GDP-10 **Government Expenditure (G):** Government purchase/borrowing of goods & services are included Government transfer payments are not included as will be accounted for in consumer expenditure **Net Export (X-IM)** = exports - imports, income leaked across national borders

Answer 5

GDP = C + I + G I = GDP - C - G C = Disposable Income - Savings Disposable Income = GDP-Tax-Transfer Savings = Percentage Saved * Disposable Income G = Tax - Transfer + Borrowing I = 600 - (600-20-10)*(1-0.2) - (10+10) I = 600 - 472 - 20 I = 108

Answer 6

* Interdependence between income & goods & services **Green** = ‘real’ economy, flow of funds associated with production & sales of g+s **Blue** = ‘financial’ economy, borrowing, lending & other flows of funds, indirect effect on production * Spending = Income = Value of factors of production = Output of firms = Spending **4 Buyers/Flows** * (1)**Government** Purchases of Goods & Services-education, defense (2)Transfer payments-social security, job insurance * **Households** engage in consumer spending/consumption: purchasing goods & services through the goods & services market * **Firms**: engage in investment spending-buying goods & services from each other, productive capital, machinery & construction of buildings * **Rest of the World:** comes from net exports-imports, goods & services sold to residents of other countries * * **Financial Markets**: provides financial instruments (loans, bonds) spent for investment. Government uses household savings that collect interests to borrow & invest, while firms compete

Answer 7

Difference is in Real GDP prices are kept constant, in nominal GDP prices vary according to each year. **Nominal GDP:** measuring GDP/aggregate output at current prices, overtime can overestimate or underestimate growth of economic activities as nominal GDP can increase even if output/quantities do not or even decrease due to price changes **Real GDP (Fixed Prices of Base Year)**: measured to make adjustment to price changes in nominal GDP, measures aggregate output/quantity produced in a year **Definition**: total value of final goods & services produced in the economy during a given year, calculated using the prices of a selected base year

Answer 8

A(1+g)^t=B → g=(B/A)^1/10 - 1

Answer 9

Percent change represents the relative change in size between x across a time period. Growth rate represents the average amount of change per year or per month of x across a time period. x could be Real, nominal GDP (per Capita), productivty, human capital per labor, etc. Growth Rate: A(1+g)^t=B Percent Change: (2-1)/1 * 100%

Answer 10

Nominal GDP 2007 = 5540 Nominal GDP 2017 = 7800 Real GDP 2007 (base 2007) = 2007Q x 2007P = 5540 Real GDP 2017 (base 2007) = 2017Q x 2007P = 6680 Growth Rate (base 2007) = (6680/5540)^1/10 - 1 = 1.889% Real GDP 2007 (base 2017) = 2007Q x 2017P = 6400 Real GDP 2017 (base 2017) = 2017Q x 2017P = 7800 Growth Rate (base 2017) = (7800/6400)^1/10 -1 = 1.998%

Answer 11

In Chained Dollar Real GDP, the average real GDP growth between every pair of consecutive years are treated to be the growth rate. Growth Rate (g) = (B/A)^1/t -1 Average Annual Growth Rate = (g1+g2)/2 Step 1: Find Real GDP of both years with both base years. Step 2: Find average annual growth rate Step 3: Choose a base year & calculate its nominal GDP Step 4: Calculate real GDP for all years based on the growth rates

Answer 12

**(Y) Real GDP per Capita = Real GDP/Population**, measure of an economy’s average aggregate output per person, those with high can afford its citizens to be healthy, education, in generally a good quality of life * % in Real GDP per Capita =% in Real GDP - %Population * %Z=%x-%y, Z=x/y **Real GDP/Population = Labor Productivity * Avg. Hour Per Worker * Proportion of Population that Work = Real GDP per Capita x Population = A * F(K, H, L)** * ***Labor Productivity** =Real GDP/Employed=Total Output/Workers or Hours Worked= y=Y/L=Af(KL,HL), output of the avg worker produces in an hour * **Avg Hr **= Total HoursTotal Employment= hours avg. worker spends at the job * **EPR** (Employment-population ratio) =EmploymentPopulation fraction of the population working * **Size of Population** Economic activities (defined by GDP) grow generally with the increase in population, therefore GDP doesn’t necessarily represent a better standard of living for the economy. Compare country to country. Only if GDP grows outpacing the growth rate of population, then at least improvement on average in the standard of living can be claimed

Answer 13

* No sufficient measure of human welfare, growth in real GDP per capita is no appropriate policy goal, although income is higher, will it be used to improve quality of life, useful summary of economic progress over time * Richer countries on average have a higher life satisfaction * Money matters less as you grow richer * Middle-income nations seem more satisfied with their lives than richer nations, money isn’t everything

Answer 14

**Disinflation**: bringing down the level of inflation * Difficult & costly when high inflation has become well established in economy as it requires a temporary but large increase in the unemployment rate * Best to avoid high inflation in the first place, must respond forcefully to signs that inflation may be accelerating **Deflation**: fall in overall price level or negative inflation Increase in price level isn’t same as rate of change in price level. Worsens standard of living.

Answer 15

1. Compare all prices of each year 2. Compare averages of all prices as observed in the market **Issues**: not all goods are equally valuable/important or accurately represent the cost of living. Ex. 100% increase in housing prices is much more important than 100% increase in electric vehicles **Solution:** Price Indexes 1. Consumer Price Index - inflation 2. Industrial Producer Price Index - inflation 3. GDP Deflator

Answer 16

Changes in aggregate price level are measured by the cost of buying a particular market basket during different years. **Consumer Price Index (fixed Q)**: monitors cost of living based on consumer expenditure survey every 4 years representing average urban household’s typical consumption & monthly price surveys, differs country to country, poorer spend high proportion for food, Japan more fish less beef * 3 components creating a price index: a market basket, a base year & normalization CPI = (Cost of Market Basket in Given Year/Cost of Market Basket in Base Year)*100

Answer 17

CPI in 2019 = not possible, P Q needed for 2 consecutive years CPI in 2020 = 370/326*100 = 113.5 CPI in 2021 =408/326*100 =125.15

Answer 18

Same rise in slope does not correlate to same inflation

Answer 19

Percent change in a price basket (Q)= (price index 2 - price index 1)/price index 1 * 100 * CPI is used to calculate official inflation rate estimate that adjusts transfer payments/tax brackets+bands yearly & private contracts (COLAs cost of living allowances), has more direct+immediate impact than GDP; transfer payments rise or fall when CPI rises or falls * IPPI Based Inflation Rate: early indicator as primary commodity prices move faster than retail prices bought by consumers, changes/responds quick to inflationary or deflationary pressures than CPI & when they perceive a change in overall demand for their goods

Answer 20

* **Cost of Living**: how much do we need to spend on a fixed consumption bundle =i=1nPiQi=P1Q1+P2Q2+... PnQn, Q held constant * **Market Basket**: {Q1, Q2,... Qn}, Q held constant, hypothetical consumption bundle used to measure changes in overall price leve

Answer 21

Industrial Producer Price Index (IPPI): measures the cost of a typical basket of g+s bought by producers, used to measure inflation based on commodity prices of raw materials

Answer 22

Current weighted price index, ratio of nominal GDP & Real GDP for that year, measure to monitor economy wide price changes, broader list of items compared to market basket =Nominal GDP for given year/Real GDP (P base) for the same year * 100

Answer 23

* All 2 price indexes fluctuate closely together * PPI most volatile as it has less prices to incorporate into an average * GDP deflator most stable as it has most prices to incorporate into an average

Answer 24

Focuses mainly on mitigating high unemployment & high inflation, goals are low unemployment & price stability which can be in conflict, important to consider tradeoff as well as sources of each, their danger & length of time

Answer 25

**Employment Rate**: those who are employed full time or part time =people employed/working age population*100 **Working Age People:** 15-64 **Labor Force**: =employed+unemployed sum people that either * Has a parttime or fulltime job * Person is not employed then looked for jobs within last 4 weeks * Available for work, no disability **Labor Force Participation** =labor forceworking age groupx100: percentage of working-age population in labor force

Answer 26

Total number of people 15-60 actively looking, available but currently aren’t employed, very good indicator of economic changes that have impact on lives, imperfect indicator of labor market conditions, how easy or difficult it is to find a job in given state of the economy, contradictory to quit rate * Without work, looking for work in past 4 weeks, and available/abled for work * Maternity+paternity leave is still employed * Temporary layoffs or waiting for new jobs are unemployed * Monthly Labour Force Survey, interviewing random sample of 56,000 HH, ask if their employed or unemployed, scaled to total population =number of unemployed/number people in labor force * 100

Answer 27

**UE Overstate True Level of UE difficulty:** confident worker who has not accepted position is counted as unemployed & normal for job search **UE Understate the True Level of UE/Measure of Labour Underutilization:** those who would like to work but aren’t working don’t get counted as unemployed Underestimation is worst than overestimation, doesn’t include * **Discouraged workers** (searching within 1 year): people who have given up searching * **Marginally attached worker**: stopped looking waiting for employment to begin, hopeful but waiting for recall, replies, new job in 5+ weeks * **Underemployment**: work not to desired capacity. **Visibly Underemployed Workers**: work fewer hours than wanted (ex. Part-Time, want Full-Time) **Invisibly Underemployed Workers**: work in jobs that don’t use skills fully, substandard to human capital (ex. Low wage, disadvantages, Immigrant, doctors, lawyers)

Answer 28

* Varies across regions (Atlantic vs Alberta), demographic groups (Young vs Old, Men vs Women), ethnicity (Black vs White), gender (Men vs Women in manufacturing vs service sector), macroeconomic conditions (commodity prices rising) & time/history (COVID) * Overall unemployment rate low, jobs are hard to find for some groups * On average, post-secondary educated have lower unemployment rates than highschool educated, especially during economic downturns

Answer 29

Strong Negative Relationship GDP Growth vs UE: as economic growth increases, unemployment decreases, but growth must be very high for unemployment rate to fall **Jobless Recovery/Growth Recession**: GDP growing below-avg rate & unemployment rising, typically following a deep recession **Job Loss recessions** create lowers standard of living of many families

Answer 30

**Natural Unemployment** Frictional Unemployment + Structural Unemployment = Unemployment present at peaks of business cycles Continual job creation & destruction are features of modern economies, making naturally occurring unemployment inevitable. Can be affected by government policies, changes over time. **Actual Unemployment Rate** Actual Unemployment = natural + cyclical

Answer 31

Voluntary, due to job search, lack of connection, constant churning in labor market, reduced through internet, exists even when D=S, no surplus of workers * UE is mainly frictional: low UE→short avg. waiting period * Limited amount may be good, more productive economy if workers take time to find well-matched jobs

Answer 32

Unemployment caused by structural change in the economy, more workers with a particular skill/wage than jobs available using that skill/wage, labor markets face constant changes, skill & wage mismatch as new technologies emerge & consumer’s tastes change, persistent surplus of labor even when economy is at peak. * Mainly Structural: low UE, long avg. waiting time * **Unions**: organization of workers that collectively bargain for better wages & benefits by threatening labor strikes, refusal to work, countered with lockouts, period in which union workers are unemployed hiring replacement workers, same results as minimum wage, wages pushed above minimum wage * **Minimum wage**: government floor ensure people can earn enough income to afford a minimally adequate standard of living, irrelevant if below equilibrium wage, above equilibrium, binding minimum wage, leads to labor surplus S>D, takes work from workers willing to work for lower wages, more people working minimum wage than before minimum wage * **Efficiency wages**: wages set above equilibrium to avoid moral hazard problem-incentivize better performance & address adverse selection problem-avoid quality problem/attract highly skilled Higher wages pool more workers to that job, causing shortage * **Government policy side effects**: employment insurance, emergency response benefit, reduces incentives to quickly find a new job

Answer 33

Actual rate - natural rate of unemployment, government regulates using fiscal & monetary policy to bolster demand, arises from the downturns of the business cycle, enough capacity, not enough demand for output * UE cyclical>frictional: high UE → jobless longer periods of time

Answer 34

structural or cyclical

Answer 35

1. **Changes in Labor Force Characteristics:** gender, age (ex. Women in the labor force incr., -25 decr., baby boom) 2. **Changes in Labor Market Institutions:** Unions, temporary employment agencies, gig economy, technological change, skill mismatch 3. **Changes in Government Policies**: jobless insurance, high minimum wage, job training programs, employment subsidies (financial incentive to accept job)

Answer 36

Rate of change/percent increase in overall prices per year level measured by price index = (Price Index 2 - Price Index 1)/Price Index 1 * 100

Answer 37

**Real Wage**= Nominal Wage/ Current CPI **Real Income** = Nominal Income/ Current CPI

Answer 38

**Interest Rate**: return a lender receives for use of their funds for a year with consideration to inflation rate that would occur in that period of time **Nominal interest rate**: stated interest rate actually paid for a loan. **Real interest rate:** nominal interest rate minus the rate of inflation r=i-r^e, Real Interest Rate (adjusted for inflation) = Nominal Interest Rate - Inflation Rate (Expected/Actual)

Answer 39

**Shoe-Leather Costs - Increased Costs of Transactions - Wear & Tear of Running**: money held in a wallet or bank during high inflation losses its purchasing power as prices rise. Avoiding holding money, moving funds into assets that will hold value, * Unproductive employment of force with frequent transferring, larger bank branches * Loss of real resources **Menu Costs**: cost of changing a listed price, to avoid constantly changing prices they switch to a more stable currency or artificial unit/set prices relative to one another, this has been reduced with electronically changing prices online * Unproductive employment of force: requires sending clerks/workers very often to change listed price with each item * No longer listing prices, multiplied by a number on a chalkboard **Unit-of-Account Costs**: costs of money as unreliable unit of measurements Financial planning impossible Reduces quality of economic decisions * Less efficient use of resources from uncertainty * Distorts measures of income & taxes collected * Pay phantom gains in productive investments (an investor's portfolio declines in value but they're still required to pay capital gains taxes) * Gain phantom losses (reduced tax bills) in unproductive investments * Discourages long-term contracts & investments

Answer 40

Prices increase at or above 50% per month = 13,000% per year=1.5^t(1.5)

Answer 41

Unexpected Inflation: Actual Inflation doesn’t equal Expected Inflation, loan contract specifies a nominal interest rate, each party has expectation of future inflation, uncertainty discourages contracts, redistributes wealth arbitrarily * A>E=Borrower Wins, returned less money/lower value than expected * AE=Lender Wins, receives more money/higher value than expected * A

Answer 42

Measured using real GDP per capita (Real GDP/Population), ability to produce steadily overtime, separates changes in quantity of g+s from prices & isolate its effect in the population.

Answer 43

Price level is different from rate of change of price level (inflation).

Answer 44

%Real GDP per Capita =%Labor Productivity + %Avg. Hours +%EPR Putting more population to work might increase growth rate for a little, but will eventually follow the growth rate of the population

Answer 45

Most Important Driver of LREG is Productivity, variables cancel out leaving just total output from productivity **Aggregate Production Function**: describes relationship b/w estimate contribution of different factors to production, labor productivity increases when these components increase Y=AF(K,L,H) **Y**: measures the real GDP **A**: total factor productivity, usually technological progress, advances in technical/distributive means of production, most important driver of productivity Not always flashy, post it notes, usually adopted by service firms **F**: aggregate production function Ex, Cobb-Douglas Production Function: y=A(KL)13(HL)23 **K**: physical capital in economy increases productivity (bike vs car): manufactured resources, non-financial, raw-materials, on hand money, buildings, tools, machineries, factories, roads, bridges & other structure production can take place **L**: employment or amount of total labor hours used in production **H**: human capital, skill + training, education & knowledge, potentially measured by the avg. years of schooling in the labor force or others, more important than physical capital

Answer 46

y=YL=Af(KL,HL)shows/disentangles how overall productivity depends on quantities of K, H, A * **(Y/L)** = real output (GDP) per worker * **(K/L)** = real physical capital per worker * **(H/L)** = human capital per worker * **A**= total factor productivity * **Y** =aggregate output, y=labor productivity

Answer 47

Use log rules, log become %change: %y=%A+13%(KL)+23%(HL) =%(Y/L)=%Y-%L

Answer 48

If exponents add up to 1 = all inputs increased the same proportion, resulting output increases by same proportion, productivity increases

Answer 49

**Positive Marginal Productivity of Factors (MPK/H)**: small increment increase in output due to smaller increase in size of 1 factor, while all others remain fixed, pervasive/not as effective as tech as every 1%=0.3% of productivity **Diminishing Marginal Productivity of Physical Capita**l: when the amount of human capital per worker & state of tech are fixed, each successive increase in the amount of physical capital per worker leads to smaller increase in output per worker, or productivity (200k vs 400k tractor not that big improvement, however 1k vs 200k is big), never reduces productivity just cost isn’t worth it when reaching a point May disappear with human capital or tech improvement with it

Answer 50

**A=Total Factor Productivity**: amount of output that can be produced with a given amount of factor inputs * Increased, economy can produce more output with the same quantity of physical capital, human capital & labor * If inputs & aggregate production stay fixed, increases in total factor productivity are due to technological progress * Shifts the aggregate production function upward

Answer 51

1. Savings & investment spending 2. Education 3. Research & development

Answer 52

Disconnect between what looks like rapid technological progress & actual productivity, flashy technologies isn’t necessarily one of rapid progress, precut cardboard boxes had more of an impact

Answer 53

Human Capital & Total Production Factor/Technology Advancements. Y-axis=productivity X-axis=Capital per Labor

Answer 54

%Real GDP per Capita = %Real GDP - %Pop = %Productivity + %Avg Hrs Worked + %EPR %Productivity = %Total Output - Total Hrs Worked

Answer 55

%Nominal GDP = %Real GDP + %Price Changes Nominal GDP = Real GDP * Price Changes

Answer 56

**Human Capital** is largely provided by governments through public education - Improvements in labour force generated by education, training, knowledge **Physical capital** is mainly created through private investment spending - Manufactured resources, buildings, machines **Financial Capital**: funds from savings available for investment spending, from domestic or positive net capital inflow, flow of funds into the country from abroad - Financial Asset (physical and financial): bonds, mutual funds, stocks, properties, businesses, confidence & dollar as hard currency makes people invest - Bonds: confidence and dollar as hard currency makes people invest, promises to pay fixed amount whatever happens - Stocks: give investors a share of future profits

Answer 57

Set of markets & institutions that channels the funds of savers into productive investment spending, increases labor productivity as it allows firms to purchase physical capital. Where governments, firms & individuals trade promises to pay in the future

Answer 58

Savings & investment are always equal.

Answer 59

G=Nx=0 S=I Y=C+I=C+S=HH consumption + savings/investment=income S=I=Y-C=Income - HH Consumption

Answer 60

Nx=0 Snational=I Y=C+I+G=Aggregate Consumption(C+G)+ Snational(I) I=S=Y-C-G=income after(-) spending I=Snational=Spublic+Spvt Spublic=T-TR-G Spvt=Y-C-T+TR

Answer 61

Budget Balance=Spublic=Sgov =Net Tax Revenue-Spending =T-TR-G - Income>Spending=budget surplus=positive - Income=Spending=budget balanced=0 - Income

Answer 62

Nx=NFI Y=C+I+G+Nx I+Nx=Y-C-G=Snational=I+X-M Nx=Snational-Inational NFI=Outflow of Funds - Inflow of Funds =IDforeign-IFdomestic =(SDforeign+SDdomestic)-(SDdomestic+SFdomestic) =SDforeign-SFdomestic =Snational-Inational Inational=Snational-Nx =SDdomestic+SFdomestic Snational=I+Nx=SDdomestic+SDforeign Nx=NFI Savings allocated by accumulating physical capital (investing domestically) or acquiring foreign assets (investing abroad) = Funds that finance domestic investment come from domestic funds (national savings) and foreign funds (capital inflow=negative NFI)

Answer 63

Net Foreign Investment = Outflow of Funds-Inflow of Funds - Outflow of Funds: foreign investment funded by domestic savings - Inflow of Funds: domestic investment funded by foreign savings Trade Balance = Export - Import - Positive O>I=E>I, Capital Outflow=Trade Surplus: more domestic investment in foreign countries, funds leaving country, funds lent to foreigners to use excess trade surplus amount - Negative O

Answer 64

**Higher national cost** the more foreign capital inflow than investment spending financed by national savings Interest on domestic savings is different from interest on a foreigner's interest. Thus, dollar generated by national savings and dollar generated by foreign capital inflow are not equivalent.

Answer 65

**Net Present Value**: present value of current & future revenues - present value of current & future costs. Best project to undertake is the one with the highest net present value **Face Value:** amount lent, price of bond at the time is was issued - **Maturity (m)**: when amount lent/face value will be returned (30-100 years usually) - 1 yr **Coupon Value (C)**: feature of bond depending on the interest offered, bond yield - $5 **Money Returned** = Face Value + Coupons **Yield Rate** = (Money Return-Face Value)/Face Value **Present Value**: future return adjusting to inflation every year **Interest Rate (i)**: inflation's affect on value/purchasing power of everything There is an inverse relationship b/w the price of a bond & the nominal interest rate 1) Make timeline 2) Find present values of coupons of each year, maturity year with principle return, C/(1+i)+C/(1+i)^2+... + C/(1+i)^(m-1)+(C+F)/(1+i)^m 3) Sum up earnings & compare with initial cost. Gives max willing to pay. If it is greater than initial cost it is profitable.

Answer 66

1) $98.19 2) $810

Answer 67

A(1+i)t=B → A=225/(1.1)1 = 204.55

Answer 68

Coupon/Annual Interest Payment=6%*1000=$60 per year Present Value at Today’s Market Equilibrium = 60/(1.05)+60/(1.05)2+60(1.05)3+60/(1.05)4+160/(1.05)5=$1043.30 Today willing to pay no more than $1043.30 or else spend $1043.30 or less on a new bond. When determining the price of a preexisting bond, the interest rate used to calculate that price is the current market equilibrium interest rate, not the interest rate that was current when the bond was originally issued.

Answer 69

When current market equilibrium interest rate is unchanged from when the bond was issued, the present value of the bond is equal to its face value, regardless of how many periods are left until it matures because r = i-tau=nominal interest-inflation rate = 6%-6%=0=no change in purchase power or value

Answer 70

Price of a bond goes up when market equilibrium interest falls. When price falls when market equilibrium interest rate goes up. When the market interest rate on comparable bonds rises, the price of existing bonds falls. When market interest rate on comparable bonds falls, the price of existing bonds rises High-risk bonds will sell at a lower price than a low-risk bond with the same maturity, face value, annual coupon payments. The lower price compensates the owner of the high-risk bond for the risk she faces of not being repaid in full

Answer 71

Bond entitles the owner to interest payments, a share of stock entitles its owner to a share of the company’s profits (dividend) as a stock represents ownership of a portion of the company. No time of maturity, goes on indefinitely Stock Price=Dividend/(1+r)+Dividend/(1+r)2+Dividend(1+r)3+... , r=interest rate, no m If company’s profits/dividends grow at a constant rate every year stock price Stock Price=Dividend/(r-Growth Rate) Highly variable dividends as profits vary year to year so stock prices are based on demand & supply

Answer 72

A hypothetical simplified market used to coordinate investors (Gov or Firms) & savers (HH), what makes S=I=Nominal Interest Rate, as there are so many different instruments to invest & borrow having their own markets with own D & S. Hypothetical to estimate one singular interest rate (i) to calculate returns, works as all interest rates a linked together, usually nominal interest rate unadjusted for inflation. D: projects of firm borrowers, firms with investment spending projects S: savings of savers, savings of the households & the government Price - price of borrowing x Quantity - quantity of loanable funds

Answer 73

Borrowers (Firms+Gov) demand for loanable funds is a downward trend due to **opportunity cost**: As the interest rate (i) goes up, the higher the opportunity cost/attractiveness of investment spending, as putting money in a bank and earn interest on it is the highest-value alternative, as cost becomes greater than investment return calculated by present value, less loaning occurs. If interest rate gets lower, the greater the quantity of loanable funds demanded as cost is less than investment return or as putting money in a bank and earn interest on it as the highest-value alternative. As interest rate increases, less loaning occurs, . - Money loses its value in the future, so use Present Value calculations to make sure that the future return adjusted to inflation is greater than the initial cost today (A=B/(1+i)). Simple Words: Interest rate=cost of borrowing. The higher i=cost of borrowing, the less demand for loans. The lower i=cost of borrowing the more demand for loans. Actual i = Nominal i - Inflation Rate - Bigger Nominal i, bigger actual i, greater value of return to lenders = more costly for borrowers - Smaller Nominal i, less actual i, smaller value of return to lenders = less costly for borrowers

Answer 74

Lenders (HH & Gov) supply of loanable funds is an upward trend due to **opportunity cost**: as interest rate increases it will become more attractive to save as return-->consumption is greater in the future than if spent now, the more people are willing to forgo current consumption and make a loan to a borrower. Actual i = Nominal i - Inflation Rate - Bigger Nominal i, bigger actual i, greater value of return/earnings to lenders= more costly for borrowers - Smaller Nominal i, less actual i, smaller value of return/earnings to lenders = less costly for borrowers

Answer 75

Interest rate at which the quantity of loanable funds supplied equals the quantity of loanable funds demanded. - Right Investments Get Made: Investment spending projects that are financed have higher payoffs than those that do not get financed - Right People do the Saving & Lending: The savers who actually lend funds are willing to lend for lower interest rates than those who do not Interest rate above equilibrium, profitable for lenders, but projects unaccepted by borrowers (Funded+Unaccepted). Below Equilibrium, profitable for projects of borrowers, but unfunded by lenders. (Unfunded+Accepted)

Answer 76

**Changes in perceived business profitability and/or opportunities:** increase or decrease amount of desired spending at any given interest rate. (ex. Fracking, technological advancement) - As demand for loanable funds rises, (i) equilibrium rises as borrowers are willing to borrow more & supply/investment increases/shifts up+right in economy - As demand for loanable funds falls, (i) equilibrium rises falls borrowers are willing to borrow less & supply/investment decreases/shifts down+left in economy **Changes in government policy that affects investment decisions decentivize & incentivize certain sectors:** - Tax Credit (allows certain sectors to pay less tax): promotes investment making it more attractive/less expensive to undertake → As more investment projects are undertaken at any level of interest, … shifts demand curve up+right… - Subsidy for investment (Ex. Clean energy technology has been incentivised by government)

Answer 77

**Changes in private savings behavior** - **Recessions** encourages households to save more, increasing loans, leads to fall → curve shifts right - **Expansion** encourages households consumption, decreasing loans → curve shifts left, fall in i **Changes in budget surplus:** - **Budget Surplus=Saver**: (T-TR)-G>0 → (T-TR)>G, SPub>0, spending less than savings → savings used to finance investment spending, shift right - **Budget Deficit=Borrower**: (T-TR)-G<0 → (T-TR)

Answer 78

Reduction of supply of loanable funds leads to rise in interest rate tells us an increasing persistent government budget deficits are a concern, businesses and households will cutback on investment spending → balancing budget is top priority

Answer 79

**Crowding Out**: negative effect of budget deficits on private investment, which occurs because government borrowing drives up interest rates In a recession crowding out may not occur, government spending can lead to higher incomes→ increased savings→ gov borrowing without increasing interest rate

Answer 80

**Global Loanable Funds Market**: international capital flows are so large that they had the effect of completely equalizing interest rates across countries - Most of the time, capital flows from countries where i is relatively low to countries where i is relatively high, resulting in raising i where it was low and reducing i where they were high - Assumption world if frictionless, ceteris paribus to describe how nominal interest rate changes between countries, however investing abroad is not frictionless as risk is involved (political volatility & currency exchange)

Answer 81

Factors driving flow of funds b/w markets: interest rate differential, risk status, (currency) exchange rate Ex. High world interest rate causes capital outflow, low world interest rate causes capital inflow from Canada to rest of the world

Answer 82

1) Savers/Lenders want higher returns/interest rate → borrowers in UK compete with US in US → capital inflow increases quantity of loanable funds supplied to US → pushes US interest down/downward pressure - Reduces supply quantity of loanable funds supplied to UK → pushing interest rate up in UK → continues until gap between interest rates is eliminated 2) Borrowers/Firms want lower interest rate, thus borrowers in US compete with UK in UK → capital outflow increases demand of loanable funds in UK → pushes UK interest up/upward pressure - Reduces demand quantity of loanable funds supplied to US → pushing interest down in US → continues until gap between interest rates is eliminated 3) US borrowers face competition, demand increases, supply decreases → excess demand - Supply quantity of loanable funds in US exceeds demand in US, excess exported in the form of capital outflow to UK UK lenders face competition so demand decreases, supply increases → excess supply - Quantity of demanded loanable funds in UK exceeds supply quantity in UK, gap filled by imported funds=capital inflow from US Excess demand & supply of both countries cancel out See notes.

Answer 83

**Comparative Advantage**: Capital moves from places where it would be cheap in the absence of international capital flows to places where it would be expensive in the absence of such flows to earn more profit.

Answer 84

r = i - tau real interest=nominal interest-inflation rate **Fisher Effect**: expected real interest rate is unaffected by changes in expected future inflation, only nominal interest rate. 1) Interest rate/equilibrium in loanable funds market corresponds to the fluctuations of the expected inflation. Thus lenders and borrowers base decisions on expected real interest rate as true cost of borrowing and true pay off of lending is real interest rate )ex. Zero-Interest Loan: 0=10%-10%) - The nominal interest rate is the accounting interest rate – the percentage by which the amount of dollars (or other currency) owed by a borrower to a lender grows over time, while the real interest rate is the percentage by which the real purchasing power of the loan grows over time. In other words, the real interest rate is the nominal interest rate adjusted for the effect of inflation on the purchasing power of the outstanding loan. 2) Change in expected inflation shifts equally both demand & supply of loanable funds simultaneously=shifts in demand and supply curves changes the interest rate; leads to a new nominal interest rate in loanable funds market, - **equilibrium quantity doesn’t change**

Answer 85

Nominal interest rate used rather than real interest rate because no one knows future inflation rate when making a deal. Expected inflation rate is held fixed based on recent experience, only nominal is dynamic **Significance**: our expectation of inflation shifts with the economy, unions base wage negotiations on expected tau

Answer 86

Role of the government in current modern economies is huge, 50% spending, changing this causes - Affects to flow of income: funds flow into G (taxes & borrowing) & funds flow out (G purchases of g+s & transfers to HHs) - Affects to aggregate demand Tool To Maintain Economy: **Fiscal Policy**: changes in taxes & G spending to stabilize the economy by shifting aggregate demand curve (AD)

Answer 87

**Goal**: to shift aggregate demand curve to close recessionary or inflationary gap **Drivers:** - DeltaC Disposable Income=total income-taxes+government transfers, T & TR government can alter. Fall/Rise in disposable income leads to a Fall/Rise in consumer spending, shifting aggregate demand - Delta C+I Incentive to Spend on Investment Goods by changing rules that determine how much a business owes, shifting aggregate demand **Types** - Direct Influence is changing G, changing demand in economy Indirect Influence is changing t or - TR, changing disposable income→ spending → demand **1) Expansionary FP when economy is in Recessionary Gap**: * Delta G spending of g+s rise, * Delta C Tax fall, Transfer Revenue rise more pension plans+social assistance * Delta I Tax breaks, incentives, subsidies **2) Contractionary FP when economy is in inflationary gap:** * Delta G Spending of g+s fall * Delta C Tax rise, Transfer Revenue fall, Less pension plans+social assistance * Delta I Tax hikes, disincentives, fines/fees

Answer 88

Although criticism in safe/ordinary economic conditions, appropriate for when the economy is depressed. In fiscal policy, timing is crucial Extent of expansionary fiscal policy effectiveness depends upon circumstances. Naturally economy will balance, could overdo things, causing inflation or recession. **1) Government spending always crowds out private spending (Wrong):** aggregate output/demand/expenditure is fixed, increasing G spending, all other factors will decrease (more taxes), total spending will not increase. Upping G spending would tax the struggling households even more. - Wrong in Principle: In reality, during recessionary gap (unemployed resources, output below potential), puts unemployed resources to work, generates higher spending & higher income (starts a multiplier effect). Only crowds out private spending when economy is operating at full employment **2) Government borrowing always crowds out private investment spending (Valid under some, but not all circumstances,):** government borrowing funds that would have been used for private investment spending, crowding them out - Wrong: if the economy isn’t depressed, incr. government borrowing → demand for loanable funds can raise interest rates & crowd out private investment. If economy is depressed (less than full employment), fiscal expansion raises incomes, increasing savings at any given interest rate, allows government to borrow without driving up interest rates - In deep recession, lots of unutilized resources, government bring back capacity, generates more income, household increase in disposable income **3) Government budget deficits reduce private spending (Raises important issues, isn’t a good argument, Ricardian equivalence):** expansionary fiscal policy leads to larger budget deficit greater debt which will require a raise of taxes to pay off, and in anticipation of this consumers will cut spending today to save money Ricardian Equivalence. Implies policy will have no effect because far-sighted consumers will undo any attempts at expansion or contraction by government - Wrong: doubtful consumers behave with such foresight & budgeting discipline, cutting back will be gradual extended period to save over time to pay future tax bill nor is policy completely ineffective. Government spending will be concentrated in the near future, consumer cuts will be much in comparison, and will bring unused resources into the economy fast enough.

Answer 89

Governments that try too hard to stabilize the economy can end up making the economy less stable due to time lags b/w when policy is decided, when it is implemented → attempts to increase spending take to long to get going, economy has already recovered on its own, turning from recessionary to inflationary gap when expansionary fiscal policy takes effect making things worse - Gov. had to realize recessionary gap exists through collection + analysis of economic data, takes months, hard to pinpoint exactly when economic events occured - Gov. has to develop spending plan taking months, particularly if politicians take time debating and passing legislation - Takes time to spend money, big projects follow small project like construction, causing some to wait

Answer 90

**Taxes**: required payments to government, collected at - National/federal level: income tax on personal income & corporate profits, social insurance taxes - Provincial/territorial level & Local/municipal level: mix of sales, property, income taxes & fees of various kinds

Answer 91

1) Direct Purchases of G+S (G expenditure approach): range from diagnostic equipment for hospitals, salaries for public school teachers, civil servants 2) Transfer Payments (C in expenditure approach as not final g+s): payments to HHs for which no g+s is provided in return - Public Pension Plans: guaranteed income to older, disabled, surviving spouses or dependent children of deceased or retired beneficiary Canadians - Other Social Assistance Payments: help HHs maintain an acceptable level of earnings

Answer 92

Social Insurance: government programs intended to protect families against economic hardships including payments form public pension plans (CPP/QPP, GIS, OAS), general welfare & family allowance payments, smaller programs (veterans' benefits, motor vehicle accident compensation payments, legal aid, daycare subsidies) - Largely paid for with special dedicated taxes on wages

Answer 93

Business cycle is driven by ups in downs by export or investment spending, and multiplier effects

Answer 94

**Informal Definition**: an initial change (rise or fall) is followed by multiple rounds of increases/decreases in aggregate output (income & expenditure), so it is used to measure the total effect of any such initial change in aggregate expenditure in the economy MPC is used **Formal Definition**: ratio of total change in real GDP caused by an autonomous change in aggregate expenditure to the size of that autonomous change - Ex. Spain additional car export causes rising output & income leads to more consumer spending leading to more income gains & so on **Equation**: Multiplier=1/(1-MPC) =1/MPS= (1+MPC+MPC^2+MPC^3+...)=AY/AAE_0, there is an eventual limit to multiplier effect leading to a fixed amount increase in aggregate income determined by MPC & MPS as each stage, rise in disposable income leaks out because it is saved

Answer 95

1) Sub in C=AC+MPC x YD into AEPlanned: AEPlanned=C+IPlanned=AC+MPCYD+IPlanned 2) Since YD=Y & income-expenditure equilibrium Y=Y*=AEPlanned: Y*=AC+MPC x Y*+IPlanned 3) Subtract MPCY* from both sides: Y*-(MPC x Y*)=AC+(MPC x Y*-MPCY*)+IPlanned Y*(1-MPC)=AC+IPlanned 4) Divide both sides by 1-MPC: y*=AC+IPlanned1-MPC 5) Let AC=C so C+IPlanned=AE0: 1/(1-MPC) x AE0 Multiplier=1/(1-MPC)

Answer 96

1) Producers are willing to supply additional output at a fixed price: without driving up overall prices with additional spending from C+I, so Aggregate expenditure=Aggregate output=Aggregate Income (fine in short run, not long run) Nominal=Real GDP 2) Interest rate is fixed → determines borrowing & investment, we take it as given 3) No government spending and no taxes, Y = C + I 4) Closed economy (X = M = O → Nx=0) 5) y0=y=Disposable Income= GDP = y - (T-TR), T=TR=0

Answer 97

MPC - Marginal Propensity to Consume: increase in consumer spending b/w 0-1 when disposable income rises by $1, as only a portion of it is spent * MPC=Delta consumer spending/Delta disposable income * Disposable Income=consumer spending + savings = Y-T+TR MPS - Marginal Propensity to Save: proportion of an additional dollar saved or not spent on consumption purposes - MPS=1-MPC,

Answer 98

Y= (1+MPC+MPC2+MPC3)*Delta AE_0 = 1/(1-MPC)*Delta AE_0

Answer 99

**Autonomous Change in Aggregate Expenditure**: initial rise/fall in aggregate expenditure at a given level of real GDP, autonomous as it is self-governing, the cause not after effect of chain reaction. Triggered by a change up & above the initial real GDP

Answer 100

* High MPC & Low MPS = more spending + less saving = high multiplier = bigger expansion = GDP growth * Low MPC & High MPS = less spending more saving = low multiplier = smaller expansion = GDP fall

Answer 101

Consumer spending accounting for 60% of toal spending of g+s

Answer 102

An equation showing how an individual household’s consumer spending varies by household’s disposable income (the greatest determinant) C=ac+MPCyd - **Upward Positive Trend**: higher disposable income, higher consumption spending - yd= individual household current disposable income - ac = Autonomous Consumer Spending: spending if HH had 0 disposable income, always greater than 0 by borrowing or using savings. Constant term, intercept, y when x=0, or plug in a point in y=mx+b after finding slope - c= individual HH consumer - MPC =c/yd=y/x= Marginal Propensity to Consume: how spending rises if current disposable income rises by $1 slope, rise/run, can be determined with any given 2 points= A(yd1,c1), B(yd2,c2) c=MPC*yd - Y-axis consumption spending, x-axis disposable income - Each dot is a household at different income and consumption spending - Below line, is HH saving, above line is HH spending savings

Answer 103

**Shifts of the Aggregate Consumption Function**: when factors other than disposable income change, aggregate consumption shifts at any level of current disposable income by 2 principle causes: 1) Changes in expected future disposable income (ex. Getting a first job, income → consumption will increase or losing job, income→consumption will decrease) * Puzzle: why does a higher income economy doesn’t necessarily mean more savings? * **Permanent Income Hypothesis** (Milton Friedman): consumer spending depends mainly on income people expect to have over the long term rather than on their current income due to systematic difference b/w current disposable & expected disposable income in individual households that creates upward trend b/w current income & savings rate * Low income often due to unusual bad year (laid off, will find job soon), expecting higher future income → low or negative savings, more spending * High income often due to unusual good year (investments that did well) expecting lower future income → high + more savings, less spending * When economy grows, current & expected incomes rise leading to higher savings→ weaker relationship b/w current income & saving 2)Changes in aggregate wealth: those with more wealth, even if all have identical income, will spend more * **Life Cycle Hypothesis**: consumers plan their spending over a lifetime not just in response to disposable income, want a consistent smooth sustained consumption level (standard of living) * Eventually people’s wealth levels off/retire without income. So to prepare they build up wealth, saving income + investing=build up in assets (wealth=value of assets) to maintain a certain living standard. * Thus, rise in aggregate wealth (Boom in stock or housing market)→ higher consumption spending in economy, vice versa * Bank Scam: offering loans to anybody not able to return loans while housing market is rising, led to crisis * Borrowing: buy house now, house will go up in value, earn money in future

Answer 104

C=3000+0.633^YD

Answer 105

**Aggregate Consumption Function**: C=AC+MPCYD derived by aggregating individual consumption spending decisions, relationship b/w aggregate current disposable income & aggregate consumer spending. Add intercepts + difference of sum of all consumer spending in an interval divided by add up all disposable income earned in same interval * YD= aggregate current disposable income/disposable income (Sum of all HH ac=y-intercepts) * AC aggregate autonomous consumer spending, a constant used to represent a situation where the HH has no income, even when disposable income is 0, C>0 * MPC=CYD, captures the amount by which the expenditure increase in response to a $1 increase in income (Sum difference of all HH consumption divided by sum difference in all disposable income)

Answer 106

**Planned Investment Spending**: the investment spending that businesses plan or intend to undertake during a given period depends on 1) **Interest Rate**: downward relationship, higher interest rate the lower the planned investment spending (IPlanned), vice versa, from comparison b/w rate of return & market interest rate (Construction, housing loans) * Fall in interest rate (cost of borrowing)→ projects/investments are more likely to be carried out as they are less costly, rate of return higher than cost to borrow, more profitable * Rise in interest rate (cost of borrowing) → projects/investments are less likely to be carried out as they are too costly, rate of return lower than cost to borrow, less profitable * Retained Earnings: past profits used to finance investment spending, doesn’t make trade off/opportunity cost any better (ex.Funds invested in machinery vs lending to collect interest) 2) **Expected Future Real GDP + Production Capacity**: firms incr/decr investment to build up stock capital, increase production output, depending on sales growth/demand for their product dictated by expected future real GDP, high levels of IPlanned occur when expected sales grow rapidly and excess production capacity will be used up * Expected Future Real GDP (Accelerator Principle): positive effect on investment spending: higher expected future GDP higher investment spending. If firms will undertake more investment spending when they expect their sales to grow. Firms will engage in lower investment spending only to replace existing capital that wears out or rendered obsolete by new technologies if sales are not expected to grow. * Current Level of Production Capacity: negative effect on investment spending: the higher the current capacity the lower the investment spending. If a firm has more capacity than needed to meet current production needs, they won’t undertake investment spending until sales catch up to excess capacity. If a firm has less capacity than required, they will undertake investment spending.

Answer 107

**Unplanned Investment Spending:** investment spending, positive or negative that occurred but was unplanned **Inventory Investment/Spending (New-Old**): value change of total inventories from unexpected fluctuations in sales held in economy during a given period of time, can hold more or less than intended * **Inventories**: stocks of goods & inputs held to satisfy future sales needs, keep a steady supply (cushion/safety against chain/supply disruption) & to quickly satisfy buyers instead of keeping them waiting to be manufactured (8.5% of GDP). * **Positive**: producing too much, unexpected increase in the value of inventory (incr. Inventory from unexpected sales) → slowing economy as sales lower than forecast ($8000 prepped for expected $8000 sales, however only $7000 sold, Inventory Investment=Planned -Actual =10-5=+5) * **Negative**: producing not enough, unexpected fall in value of inventory (unexpected sales, spoilage) → growing economy as sales greater than forecast (Inventory Investment=Planned -Actual =10-15=-5)

Answer 108

I=Iplanned+Iunplanned

Answer 109

**Income-Expenditure Model**: as income increases, planned expenditure increases as well, consequently seen in AD model, shown numerically, graphically & algebraically * No Government + Closed Economy * Prices aren't fixed GDP=C+I= YD=AEPlanned+IUnplanned, C=AC+MPC*YD, IPlanned fixed=Y-AEplanned

Answer 110

AEPlanned=C+IPlanned: total amount of planned expenditure in the economy, as households don’t take unintended actions. AEPlanned depends on GDP: Higher GDP → higher disposable income → higher consumer spending → higher planned aggregate expenditure → higher GDP… multiplier effect, vice versa.

Answer 111

**Income-Expenditure Equilibrium**: Y=AEPlanned, IUnplanned=0, no unplanned inventory investment, firms don’t have an incentive to change output, any point on the Keynesian Cross (45 degree) is the equilibrium. AEPlanned differs from Y when IUnplanned=0 * Firm’s will adjust output/production to eliminate unanticipated changes in inventory & reach equilibrium * Since GDP=AEPlanned+IUnplanned IUnplanned=Y-AEPlanned * Below equilibrium AEPlanned>Y, underproduction as IUnplanned=-ve, underestimate * Firms incr. production → GDP incr. * Above equilibrium AEPlanned

Answer 112

Y*1Y*2 AEplanned = C + Iplanned **1) Change of Aggregate Consumption Function (C)**: change expected future disposable income and/or in aggregate wealth, leads to Autonomous Change in Planned Aggregate Expenditure (AE0): change in desired level of spending of whole economy at any given level of real GDP Rise in income expenditure equilibrium greater than AE0 due to multiplier effect=Delta Y*/DeltaAEPlanned → Y*=Multiplier*AE_0 **Process In Depth**: (X→E1)AE0 incr. Gap b/w AEPlanned & Y→Production rises → GDP rises (Y1→Y2) → Disposable income rises → C rises → Real GDP rises → YD again loop… Vice versa as well **2) Change in Investment Spending (IPlanned)**: change in interest rate, expected future GDP, production capacity, inventory investment from unexpected fluctuations in sales

Answer 113

**Autonomous Change in Planned Aggregate Expenditure (AE0)**: change in desired level of spending of whole economy at any given level of real GDP =DeltaY*/Delta AEPlanned

Answer 114

1) Export=Income=Spending=AE0 2) Multiplier effect weaker/lower depending on Marginal Propensity to Import (MPI) as C=ImportGDP domestic Algebraic: AEp=C+Ip+(X-M) * Export: x=x0, fixed, depends on foreign GDP, not ours * Import: M=my, 0

Answer 115

Based on the income-expenditure model shows change in AEplanned curve, shows how much aggregate output demanded (real GDP) by HH, firms, gov, rest of world, at any given aggregate price level (GDP Deflator) **Downward sloping relationship**: higher the aggregate price level reduces quantity of aggregate output demanded, lower aggregate price level increases quantity of aggregate output demanded **1) Wealth Effect**: the effect on consumer spending caused by the effect of a change in the aggregate price level on the purchasing power of consumers’ assets * an increase in aggregate price level reduces the purchasing power of many assets, causing a scaling back in aggregate consumption plans, aggregate demand falls (ex.25% rise in GDP deflator = $5,000 in the bank → becomes $4000) * P rise, PP fall, C fall * A decrease in aggregate price level increases the purchasing power of many assets, causing a scaling up in aggregate consumption plans, aggregate demand rises (ex.25% fall in GDP deflator = $5,000 in the bank → becomes $6,666) * Downward shift of the AEplanned **2) Interest Rate Effect**: a rise in the aggregate price level depresses investment and consumer spending through its effect on the purchasing power of money holdings * Money is held to reduce the cost & inconvenience of making transactions. An increase in aggregate price level reduces purchasing power of a given amount of money holdings. This results in less supply and high demand of loanable funds as more borrowing or selling of loans occurs to increase money holdings and less money is saved in bank accounts, driving up interest rates. * Rise in interest rate reduces investment spending as cost of borrowing is higher, and reduces consumer spending as money is saved. * P rise, Hold money fall, buy today rise, savings fall, interest rate rise to attract people to save, cost of borrowing rise, investment fall, consumption fall * Downward shift of the AEplanned Not law of demand as the AD curve considers a simultaneous change in the prices of all final goods & services, the basket of g+s is irrelevant. Law of demand hinges on how specific prices don’t change and the variety of the basket

Answer 116

Aggregate expenditure at any given aggregate price level is derived from the Income-Expenditure model that no longer has fixed planned aggregate spending (C+I=y), prices are not fixed. Shifts in the Income-Expenditure Model caused by changes in the aggregate price level derive the AD curve. * Income-expenditure equilibrium: planned aggregate expenditure crosses the 45 degree line (keynesian cross) * When aggregate price level changes, the income-expenditure model shifts: * Ex. A fall in aggregate price level causes AEplanned curve to shift up * Fall in aggregate price level causes an upward shift of the Income-Expenditure Model and a rise in real GDP → downward trend of AD curve

Answer 117

**1) Changes in expectations of the future:** Optimistic aggregate spending rises, pessimistic aggregate spending decreases due to a decrease in autonomous consumption & investment * Delta C: consumer spending is based on income they expect to have in the future (ex. Expected income → planned consumption rises→aggregate consumption/expenditure/output shifts up). * Delta Iplanned: firm investment spending is based on sales they expect to make in the future **2) Changes in wealth Delta C**: independent of changes in price index, real prices of assets rise/fall → purchasing power rise/fall → aggregate expenditure rise/fall * Ex. Housing bubble, everybody buying homes, banks making loans to people uncredited worthy, banks have no risk will sell, aggregate spending rises. When it burst, price levels of assets fell, aggregate spending fell. **3) Size of the existing stock of physical capital Iplanned:** investment spending depends on how much physical capital they have small/large & the more/less they need * Ex. China, real estate ghost towns as borrowing was too easy, there isn’t much demand, too much stock of physical capital, massive drop in investment in the sector, aggregate spending falls as price levels fall. **4) Fiscal policy**: use of government spending or tax policy to stabilize the economy through contractionary & expansionary aims. Governments are 50% of World GDP, a huge share in the modern economy, what they do has a huge influence on the economy. Given this role, they can shift aggregate demand by changing household and firms decisions, indirectly influence *** Increasing aggregate demand → expansionary fiscal policy**, (1)direct-buy more stuff G, (2)indirect-transfer more disposable income to up consumption spending TR, (3)reducing tax more disposable income to spend T (sales, federal, provincial), combination of 3 * **Decreasing aggregate demand → contractionary fiscal policy -** opposite of the combination of 3 (1)direct-buy less G (2)indirect-transfer less disposable income to lower consumption spending TR (3)increasing tax to reduce disposable income to spend T **5) Monetary Policy:** use of changes in the quantity of money or the interest rate to stabilize the economy, contractionary and expansionary * **Increasing aggregate demand → expansionary monetary policy * Expansionary -** * Increasing quantity of money in circulation→ firms+HH have more money willing to be lent out, drives interest rate down * Decrease interest rate→make money cheaper→will borrow more→ more investment spending → increases AD *** Decreasing aggregate demand → Contractionary monetary policy** - increase interest rate, money expensive, will borrow less, less investments, more savings * Decrease quantity of money in circulation→ firms+HH have less money willing to be lent out, drives interest rate up * Increase interest rate→make money more valuable→will borrow less→ less investment spending → decreases AD

Answer 118

Shows as aggregate price level (GDP deflator) rises aggregate output supplied (real GDP) rises, a fall of aggregate price level causes a fall in aggregate output supplied due to the greater than or less than cost of producing that unit of output. * Short Run Aggregate Supply Curve * Long Run Aggregate Supply Curve

Answer 119

**Short Run AS Curve (SRAS):** no change in technology & input prices don’t change, Sticky prices, takes times for prices to change due to shocks in economy, slower to change. - Potential Aggregate output different from Aggregate Output; Below Potential or Above Potential, shifts until the point where LRAS and SRAS intercept is at the Potential Aggregate Output * Wages are the stickiest/most inflexible/fixed: any worker compensation, health care, retirement benefits, addition to earnings, because nominal wage=sticky wages is often determined by contract signed long before or informal agreements. Firms will only reduce wages if the downturn has been long or severe for fear of generating worker resentment or raise wages until at risk of losing workers to competitors during good economic times to not encourage workers to routinely demand higher wages. **Long Run AS Curve (LRAS)**: technological improvement is a possibility and all, both output & input prices are flexible; long enough for input prices/wages to adjust to changes in price index. Aggregate price level has no effect on the quantity of aggregate output supplied as prices and costs adjust proportionally the same, changes in aggregate price level, composed of prices of final g+s, will be accompanied by equal proportional changes in all input prices, including nominal wages

Answer 120

**Upward Slope driven by nominal sticky wages/prices & profit per unit of output**, as some production costs are fixed in the short run, a change in aggregate price levels leads to a change in producers’ profit per unit of output → change in the profit-maximizing level of aggregate output supplied **Perfectly Competitive Firms**: Price takers, can’t influence price, operate where their MC Marginal Cost curve is at or above the AVC Average Variable Cost Curve, s **If aggregate prices decreases**, profit per unit of output decreases and input prices are fixed → reduces per unit profit → reduces supply in short run To limit decline in per unit profit costs need to be cut → land, capital, technology, wages are fixed in short-run only option is to decrease the level of labor **Law of Diminishing Marginal Productivity:** marginal product of labor declines as the number of workers employed rises, implying layoffs raise marginal productivity of labor lowers production costs & increases profit Costs greater than price → labor level falls, marginal productivity rise, marginal cost fall, per unit profit rise at the new price, output/supply falls to mitigate drop in profit per unit If aggregate prices rise, higher price for final g+s, profit per unit rises as production costs are fixed and price of unit rises → output increases as more profitable **Imperfectly Competitive Firms: Price makers**, they decide price when they they have market power **Rise in demand** → output increases at any given price → with pricing power will choose to increase price + output to increase profit per unit of output **Fall in demand** → limit fall in sales by cutting prices + lowering output

Answer 121

Per Unit Profit of Output drives firm’s decisions, greater more, less less which changes depending on cost of production: increase cost → profit falls →production fall → output fall, vice versa **1) Changes in Commodity Prices while output prices do not change:** are not final goods, hence not included in aggregate price level, are a significant cost of production having large impacts, volatile due to industry-specific shocks to supply * Commodity: standardized input bought & sold in bulk quantities (refined inputs aluminum, iron, oil, nickel, potash, copper) **2) Change in Nominal Wage**: enough time passed for contracts for informal agreements to be renegotiated, * Ex. Healthcare insurance, Minimum wages for addressing sticky wages, increased cost of production, profit decr.--> aggregate output shift left. * Knock-On Effect: surge in oil prices commodity price raised overall consumer prices → nominal wages with cost-of-living-allowances **3) Changes in Productivity:** ex. Barcode scanners, * P: less stuff to produce the same amount = improvement in productivity → less cost per output → increase in aggregate supply **4) Change in Regulation**: ex.Filing more reports, forms * R: fall of productivity from inefficient use of time → higher cost of production → reducing production → shift in aggregate output

Answer 122

**Vertical graph**: firms makes adjustments, need to reduce labor is no longer a problem, no relationship, same output is produced at all price levels, Potential output reached **Horizontal Intercept = economy’s Potential Output**: the level of real GDP the economy would produce if all prices were perfectly flexible, not maximum level of output, output when all factors of production are effectively & fully utilized. In reality, output is always above or below gravitating towards/fluctuating around it. Other names: full employment level, long-run equilibrium level of output, natural rate level of output. Determined by the production capacity using production function: labor force, capital stock, resources, technological improvement, and Long-Run Economic Growth factors

Answer 123

Always in 1 of 2 states, both curves simultaneously if they cross (Aggregate Output=Potential Output) or SRAS shifting over time until they intersect * GDP>Potential Output → low profits low unemployment, need for workers, rise in bargaining power for wage → rise in nominal wages → production cost rise → supply decreases to Potential Output * GDP high profits high unemployment, too many workers, fall in bargaining power for wage → fall in nominal wages → production cost falls → supply increases to Potential Output

Answer 124

**Short-Run Macroeconomic Equilibrium (ESR):** intersection at which AD & SRAS curves intersect, quantity of aggregate output supplied is equal to the quantity demanded by HH, firms, government & rest of the world * P_E Short-Run Equilibrium Aggregate Price Level * Y_E Short-Run Equilibrium Aggregate Output * If aggregate price level is above E, SRAS>AD → aggregate price level will fall to E * If aggregate price level is below E, SRAS

Answer 125

**Demand Shock/Shifts of Aggregate Demand (AD) Curve:** an event causes AD curve to shift, while aggregate supply stays fixed, caused by factors listed above changes in expectations, wealth, effect of the size of existing stock of physical capital, use of fiscal or monetary policy. Aggregate output and price levels move in same direction **Positive Demand Shock**: aggregate demand increases (AD shift right), short-run price levels and output rise, higher equilibrium, upward movement along SRAS curve ex. an expansionary fiscal policy shifts the AD curve to the right (see factors that shift demand above), solved the Great Depression **Negative Demand Shock**: aggregate demand decreases (AD shift left), short-run price levels & output fall, lower equilibrium, downward movement along SRAS curve ex. Recession abroad cause a negative demand shock → fall in export, Contractionary fiscal policy, less spending, less demand, Monetary make spending more costly, buying less, less demand (investment spending is particularly sensitive)

Answer 126

**Supply Shock/Shifts of Aggregate Supply (SRAS) Curve**: an event causes the SRAS curve to shift, changes in costs of production causes profit to change (see factors listed above; change in commodity prices, nominal wage, tech/productivity), aggregate output & aggregate price level move in opposite directions. Harder for government to shift. **Positive Supply Shock (favourable)**: an event causing per unit profit to increase for the given price level that reduces production cost & increases quantity supplied at any given price level (SRAS right shift) → short-run price levels fall & output rises, downward movement along AD curve * Technological improvement, internet 1995-2000 * Declining inflation + full employment, optimism **Negative Supply Shock**: an event causing the per unit profit to decrease that raises production costs & reduces the quantity producers are willing to supply at any given aggregate level (SRAS left shift) → short-run price levels rise & output falls, upward movement along AD curve * Increase in oil prices 1973 & 1979, drives permanent rise in cost, reduces supply * **Stagflation** (stagnation+inflation): inflation/rising aggregate price levels & falling aggregate output leads to rising unemployment, purchasing power squeezed by rising prices, pessimism

Answer 127

**Long- Macroeconomic Equilibrium (ELR)**, when the short-run macroeconomic equilibrium is on the long-run aggregate supply curve. All 3 curves must agree AD, SRAS and LRAS. Long Run the economy is self-correcting, Output is unaffected, Price Levels are affected in Long-Run * P_E Long-Run Equilibrium Aggregate Price Level * Y_P Potential Output = Long-Run Equilibrium Aggregate Output

Answer 128

**Output Gap**: percentage difference b/w actual aggregate output (Short-Run) & potential output (Long-Run) =(Actual Aggregate Output-Potential Aggregate Output)/Potential Aggregate Output x100, always tends to 0, the YP * (-ve) **Recessionary Gap**: YEYP aggregate output is above potential output, nominal wages + sticky prices rise, moving back to YP

Answer 129

**E1 (LR)**: all 3 agree at one point, long-run aggregate supply curve Y1=YP **E2 (SR)**: AD falls (left) → fall in P2 and Y2 as suddenly the economy doesn’t want to buy→produce as much as E1 → below potential output and recessionary gap created (high unemployment, no need for so many workers for little demand or production) In the long run, even if the government does nothing, naturally SRAS will increase, as high unemployment=bargaining power for wage decreases, nominal wages fall=downward pressures on prices, production costs decrease, upward push on SRAS to increase output as profit per unit rises until… **E3 (LR)**: will return to equilibrium of all 3, long-run macroeconomic equilibrium, Y3=YP, lower aggregate price level P3

Answer 130

**E1 (LR)**: all 3 agree at one point, long-run aggregate supply curve Y1=YP **E2 (SR)**: AD increases (right shift), suddenly the economy wants to buy→produce more than E1, P2 & Y2 rises above potential output and inflationary gap created (low unemployment to produce higher level of aggregate output) In the long run, even if the government does nothing, naturally SRAS will decrease, more firm competition, higher bargaining power for wages, upward pressures on wages, production costs increase, downward left push on SRAS decreasing output until.. **E3 (LR)**: will return to equilibrium of all 3, long-run macroeconomic equilibrium, Y3=YP, higher aggregate price level P3>PE

Answer 131

Recessions are mainly caused by demand shocks, negative supply shocks tend to be more severe stagflation=inflation+falling output as macroeconomic policies have a harder time dealing with supply shocks. Biggest from Oil conflicts.

Answer 132

Y*: GDP=AEp=YD AEp = C + Iplanned = AC + MPC*YD+Iplanned Set GDP=AC+MPC*GDP+Iplanned & isolate for GDP

Answer 133

See mindmap