Economics Flashcards
Economic Indicators Leading - Coincident - Lagging -
- Leading: Turning points occur ahead of peaks and throughs (Stock prices, initial unemployment claims, manufacturing new orders)
- Coincident: Turning points coincide with peaks and troughs (Nonfarm payrolls, personal income, manufacturing sales)
- Lagging: Turning points follow peaks and throughs (average duration of unemployment, inventory/sale ratio, prime rate)
4 phases of the business cycle
- Expansion (real GDP is increasing)
- Peak (real GDP stops increasing and begins decreasing)
- Contraction or recession (real GDP is decreasing)
- Trough (real GDP stops decreasing and begins increasing)
Expansionary and contractionary monetary policy
Monetary policy is expansionary when the policy rate is less than the neutral interest rate (real trend rate of economic growth + inflation target) and contractionary when the policy rate is greater than the neutral interest rate.
Expansionary and contractionary fiscal policy
Fiscal policy is expansionary when a budget deficit is increasing or surplus is decreasing, and contractionary when a budget deficit is decreasing or surplus is increasing.
Price Elasticity
Income elasticity
Cross price elasticity
Breakeven and Shutdown
Breakeven: total revenue = total cost
Operate in short run:
Total variable cost < total revenue < total cost
Shut down in short run:
Total revenue < total variable cost
Profit maximizing point
Marginal revenue = marginal cost
Real GDP =
consumption spending + investment + government spending + net exports
Savings, Investment, Fiscal Balance, and Trade Balance
(G - T) = (S - I) - (X - M)
Fiscal budget deficit = excess saving over domestic investment - trade balance
Equation of exchange
money supply × velocity = price × real output (MV = PY)
Where velocity is the average times per year each unit of money is used to buy goods or services
Money Neutrality
The belief that real variables (real GDP and velocity) are not affected by monetary variables (money supply and prices)
Recessionary gap, inflationary gap, and stagflation
- Recessionary gap: Real GDP < full employment GDP
- Inflationary gap: Real GDP > full employment GDP
- Stagflation is simultaneous high inflation and weak economic growth, which can result from a sudden decrease in short-run aggregate supply.
Type of unemployment
- Frictional: time lag in matching qualified workers with job openings.
- Structural: unemployed workers do not have the skills to match newly created jobs.
- Cyclical: economy producing at less than capacity during contraction phase of business cycle.
Effective central bank
- Independence: The central bank is free from political interference.
- Credibility: The central bank follows through on its stated policy intentions.
- Transparency: The central bank makes it clear what economic indicators it uses and reports on the state of those indicators.
Money multiplier
Money multiplier = 1 / reserve requirement
Money created = new deposit x money multiplier
Fiscal multiplier
The fiscal multiplier determines the potential increase in aggregate demand resulting from an increase in government spending:
Fiscal multiplier = 1 / [1 − MPC(1−t)]
Where MPC = marginal propensity to consume
t = tax rate
Balance of payments: current account, capital account, and financial account
- Current account: merchandise and services; income receipts; unilateral transfers.
- Capital account: capital transfers; sales/purchases of nonfinancial assets.
- Financial account: government-owned assets abroad; foreign-owned assets in the country.
Regional Trading Agreements:
Free trade area
Customs union
Common market
Economic union
Monetary union
- Free trade area: Removes barriers to goods and services trade among members.
- Customs union: Members also adopt common trade policies with non-members.
- Common market: Members also remove barriers to labor and capital movements among members.
- Economic union: Members also establish common institutions and economic policy.
- Monetary union: Members also adopt a common currency.
Real Exchange Rate
= nominal FX rate × ( base currency CPI / price currency CPI )
= (Price currency / base currency) x ( base currency CPI / price currency CPI )
No-arbitrage relation (Forward / Spot)
The percentage difference between forward & spot exchange rate is approximately equal to the difference between the two countries’ interest rate:
Forward / Spot = (1 + i price currency) / (1 + i base currency)
The currency with high interest rate should depreciation over time by approximately the amount of the interest rate differential
Exchange rate regimes
- Formal dollarization: country adopts foreign currency.
- Monetary union: members adopt common currency.
- Fixed peg: ±1% margin versus foreign currency or basket of currencies.
- Target zone: Wider margin than fixed peg.
- Crawling peg: Pegged exchange rate adjusted periodically.
- Crawling bands: Width of margin increases over time.
- Managed floating: Monetary authority acts to influence exchange rate but does not set a target.
- Independently floating: Exchange rate is market- determined.
Fisher effect
Nominal interest rate = real interest rate + expected inflation rate
Business Cycle Theories:
Neoclassical economists
Keynesians
New Keynesians
Monetarists
Austrian-school economists
Real business cycle theory
- Classical: Cycles are temporary deviations from long-run equilibrium that self-correct
- Neoclassical economists: Business cycles are temporary and driven by changes in technology. Cycles are rational responses to changes in real economic variables. Rapid adjustments of wages and other input prices cause the economy to move downward.
- Keynesian economists: Excessive optimism or pessimism among business managers causes business cycles. Cycles do not self-correct due to “downward sticky” wages. Contractions can persist because wages are slow to move downward.
- New Keynesians: Input prices other than wages are also slow to move downward.
- Monetarists: Inappropriate changes in the rate of money supply growth cause business cycles. Money supply growth should be maintained at a moderate and predictable rate to support the growth of real GDP.
- Austrian-school economists: Business cycles are initiated by government intervention that drives interest rates to artificially low levels.
- Real business cycle theory: Business cycles result from utility-maximizing actions in response to real economic changes, such as external shocks and changes in technology. Policymakers should not intervene in business cycles.
Price Discrimination
- First-degree price discrimination, where a monopolist is able to charge each customer the highest price the customer is willing to pay. the entire consumer surplus is captured by the producer, as such the consumer surplus falls to zero (diminished).
- Second-degree price discrimination the monopolist offers a menu of quantity-based pricing options designed to induce customers to self-select based on how highly they value the product.
- Third-degree price discrimination happens when customers are segregated by demographic or other traits.
Laspeyres index
Paasche index
Fisher index
- Laspeyres index uses the base year composition of the basket (base year quantity)
- Paasche index uses the current year composition of the basket (current year quantity)
- Fisher index is the geometric mean of the two indice above
- Using a fixed basket of goods and services has three serious upward biases:
- Substitution bias
- Quality bias
- New product bias
Calculating GDP
The sum-of-value-added method involves summing the value added (or income created) at each step in the production and distribution process.
The value-of-final-output method is based on the final selling price consumers pay for products and services (the retailer’s receipt from the final customer).
Marshall-Lerner condition and change in trade balance
The condition under which a depreciation of the domestic currency will decrease a trade deficit.
εML = WX εX + WM (εM – 1) > 0
where:
- εML = Marshall–Lerner trade-weighted elasticity
- Wx = proportion of total trade that is exports
- Wm = proportion of total trade that is imports
- εX = price elasticity of demand for exports
- εm = price elasticity of demand for imports
Change in Trade Balance = εML × Total Trade × Depreciation
Forward rate vs. spot rate
Forward rate = spot rate x [( 1 + Interestprice currency ) / ( 1 + Interestbase currency )]
Forward rate = spot rate + forward premium
Policy rate
In the United States, banks can borrow funds from the Fed if they have temporary shortfalls in reserves.
An increase in the policy rate will likely raise the potential penalty that banks will have to pay if they run short of liquidity and thereby reduces their willingness to lend.
Commercial banks normally increase their base rates immediately (not gradually) following the announcement of an increased policy rate because they want to avoid the possibility of lending at rates lower than they might be charged by the central bank.
If policy rate < Neutral rate, expansionary. Vice versa.
Neutral rate = real trend rate of growth + long-run expected inflation
Participation Rate and Unemployment Rate
Participation ration = number of people in the labor force / total population of working-age people
Unemployment rate = number of people unemployed / number of people in the labor force
Crowding-out effect
The crowding-out effect is when the government runs a deficit and must borrow more, which increases the demand for loanable funds. This causes interest rates to increase. At the higher rates, firms invest less in physical capital. The effect of expansionary fiscal policy is reduced by the crowding-out effect.
Three primary factors influencing the price elasticity of demand for a product
- The availability and closeness of substitute goods
- The proportion of income spent on the product, and
- The time since the price change.
Calculate personal income and disposable income.
- Personal income = national income + transfer payments - indirect business taxes - corporate income taxes - undistributed corporate profits
- Disposable income = personal income - personal taxes
Disinflation
Disinflation occurs when prices are increasing, but at a decreasing rate.
Structural Deficit
The structural deficit is the deficit that would exist if the economy was at full employment (or full potential output)
