Exam 2 Flashcards
Financial system
The group of institutions that helps match the saving of one person with investments of others
Bond
Certificate of indebtedness
Bond maturity
Finite time period at the end of which the bond will end and the principle is repaid with interest
Bond principle
Face value of the bond
Bond risk
That interest rates will change
Financial intermediaries
Institutions through which savers can indirectly provide funds to borrows
Example of financial intermediaries
Banks and mutual funds
Mutal funds
Sell shares to the public and use the proceeds to buy portfolios of stocks and bonds
Crowding out effect
The government borrows to finance its deficits leaving less funds avalible for investment
Natural rate of unemployment
Normal rate around which actual fluctuates
Cyclical unemployment
The deviation of unemployment from its natural rate
(Natural-average)xamount of years
Frictional unemployment
When workers spend time searching for the jobs that best suit there skills and taste
Structural unemployment
When there are fewer jobs than there are workers
Unemployment insurance
A government program that partially protects workers incomes when they become unemployed
Efficency wages
Firms voluntary pay above equil wages to boost productivity. Worker health, worker turnover, worker quality, work effort
Unions
Higher wages but higher unemploy, outsiders worse off
Min-wage law
May exceed equil wage causing structural unemployment
Barter
The exchange of one good and service for another
Double coincidence of wants
Two people have what the other wants. Need for barter
Commodity money
Takes form of commodity with intrinstic value
Fiat money
Money without intrinsic value. Value because of gov decree
Demand deposits
Balances in bank accounts that depositors can access on demand by writing a check
Fractional reserve banking system
Banks keep a fraction of deposits as reserves and use the rest to make loans
Money multiplier
The amount of money the banking system generates with each dollar of revenue (1/R)
Leverage
The use of borrowed funds to supplement exisiting funds for investment purposes
Open market operations
Purchase and sell of us gov bonds
Discount rate
Interst rate on loans the fed makes to banks
Federal funds rate
Interest rates on loans from other banks
Value of money
1/P
Relative price
The price of one good relative to another. Relative price of CD=price CD/price of pizza=1.5 pizza/CD
Classical dichotomy
Separation of real and nominal variables. Nominal variables change but real dont
Monetary neutality
Changes in money supply do not effect real variables
Volicity of money
(PxY)/M
Hyperinflation
Inflation exceeding 50% each month
Inflation tax
The revenue from printing money
Fisher effect
Nominal interest rate adjust one for one with changes in the inflation rate
Trade deficit
Imports>exports
Trade surplus
Exports> imports
Net capital outflow
Domestic residents purchases of foreign minus foreign purchasr of domestic
Nominal exchange rate
The rate at which one countries currecy trades for anothers
Appreciation
Increase value of a currency as measured by the amount of foreign it cam buy
Depreciation
Decrease in the amount of foreign it can buy
Real exchange rate
(Nominalx domestic price)/ foreign price
Natural rate of output
Amount of output when unemp is at its natural rate
Full employment output
The sames as natural rate of output
Short run aggregate supply
Upward sloping, total quanity firms sell at given price level
Long run aggregate supply
Vertical
Stagflation
Period of falling output and rising prices
Liqudity trap
When interest rate is zero
Expansionary
Increase G and decrease T to shift AD left
Contrationary
Decrease G and increase T to shift AD left
Multiplier effect
Additional shifts in AF that results when fiscal policy increases consumer spending
Monetary policy
Changing MS
Fiscal ploicy
Changing G and Taxes
Marginal propensity to consume
The fraction of extra incomr that households consume rather than save (c/rise income)
Automatic stablizers
Taxes auto go down increase AD, gov spends more on assistances increase AD
Phillps curve
Shows trade off between inflation and unemployment
Disinflation
A reduction in inflation rate
Sacrifice ratio
Percentage points of annual output lost per 1 percentage point reduction in inflatiob
Short run phillps curve
Downward sloping
Long run phillips curve
Vertical line
Private savings
Household income not used for consumption or paying taxes
Y-T-C
Public saving
Taxes-Government spending
National saving
Private plus public saving
Y-C-G
Investment
The purchase of new capital
Saving incentives
Tax incentives for saving increase supply of loanable funds which reduces the equil interest rate and increases equal quanity
Investment incentives
Investment tax credit increases the demand for LF which raises interst rate and increases quanity
What happens when a budget deficit crowds out investment
Reduces the growth and productivity and GDP
Unemployment rate
100x (#of unemployed/labor force)
Labor force participation rate
100x (labor force/adult population)
U-rate not perfect
Excludes discouraged worker, no distingishtion between full and part time, misreporting
Medium of exchange
Function of money that is an item buyers give to sellers when they want to purchase goods and service
Unit of account
Function of money that is the yardstick people use to post prices and record debts
Store of value
A function of money that is an item people can use to transfer purchasing power from the present to the future
M1
Currency, demand deposits, travelers check, and other checkable deposits
M2
Everything in M1 plus savings deposits, small time deposits, mutual funds, and a few minor categories
Reserve ratio (R)
Reserves/deposits
Money supply with reserves
Money multiplier x bank reserves
Leverage ratio equation
Assets/capital
What happens when fed increases money supply
Value of money falls and P rises
Real wage
The price of labor relative to the price of output. W/P
The quanity equation
MV=PY
Shoeleather cost
Cost of inflation that are the resources wasted when inflation encourages people to reduce their money holding
Menu cost
Cost of inflation that is the cost of changing prices
Misallocation of resources from relative price variability
Firms dont all raise prices at same time, relative prices can vary, which distorts the allocation of resources
Confusion and inconveniences
Complicates long range plannkng and the comparison of dollar amounts over time
Tax distortions
Cost of inflation that causes people to pay more taxes even when their real incomes dont increase
After tax real interest rate
Nominal (1-tax rate x interest rate) minues inflation rate
Real interest rate
Nominal-inflation rate
Foreign direct investment
Domestic residents activly manage the foreign investment
Foreign portfolio investment
Domestic residents purchase foreign stocks or bonds supplying Lf to a foreign firm
NCO is greater than zero
Domestic purchases of foreign assets exceed foreign purchases of domestic
NCO is less than zero
Foreign purchases of domestic assets exceeds domestic purchases of foreign assets
Law of one price
The notion that a good should sell for the same price in all markets
Purchasing power parity
A theory of exchange rates whereby a unit of any currency should be able to buy the same quantity of goods in all countries
Limitations of PPP
Many goods cannot be easily traded: prices cannot be arbitraged. Foreign and domestic goods not perfect subs, price differences reflect different taste
How do we measure economic fluctuations?
With aggregate demand and supply
AD curve shifts because of C
Stock market, preferences, and taxes
AD shifts because of I
Firms buy new equiptment, expectations, interest rate, monetary policy, tax incentives
AD shifts because of G
Federal spending and state and local spending
AD shifts because of NX
Booms/recessions in countries that buy exports, appreciation/depreciation in foreign exchange market
Long run supply curve is
The natural rate of output
LRAS shift because of changes in labor
Immigration, baby boomers, gov policy reduce urate
LRAS shift because of capital
Invest in factories and equiptment, more college degrees, weather damage
LRAS shift because of natural resources
New mineral deposit, reduced oil supply, changing weather
LRAS shift because of technology
Increase improvement in technology
Sticky wage theory
Nominal wages are sluggish to adjust because firms set wages in advance based on Pe
Revenue is higher but labor isnt so increase output
The sticky price theory
Firms set sticky prices in advance based on Pe. Menu prices make prices low and demand high so increase output
Misperceptions theory
Firms believe realitive price is rising and may increase output
AS equation
Output=natural output rate+a(P-Pe)
Long run equil
Pe=p and Y=Yn and unemp is at its natural rate
What causes stagflation
Shift left of SRAS
Interest rate effect
A fall in P reduces money demand which lowers r which increasss I and the quanity of g and s demanded moving down AD curve
A fall in P
Reduces money demand
Money demand is determined by
How much wealth people want to hold in liquid form. Output, rate, and price influence
Fed uses what to reduce AD
Reduce MS which raises R which then reduces quanity of g and s demanded
Does monetary policy work in liquity trap
No because interest rates cannot be reduced farther than zero
Fiscal policy crowding put effect
The size of AD shift may be smaller than inital fiscal expansion
G increase and AD increase by same but then higher Y increases MD and R which reduces AD
Phillips curve equations
Urate= natural urate- a(actual inflation-expected)
Supply shock
An event that directly alters firms cost and prices shifting AS and phillips curve
Supply shock shifts phillips curve
SRAS shifts left, prices rise and output and emp fall. Inflation and urste increse as phillps shifts upward
