Exam 2 Review Flashcards
production function
shows you how much output the economy can produce from K units of capital and L units of labor
- exhibits CRS
- reflects economy’s level of technology
assumptions about production function
- technology is fixed
2. economy’s supplies of capital and labor are fixed
disposable income
total income minus total taxes (Y-T)
consumption function
C = C ( Y - T )
-shows that (Y -T ) changes( disposable income), consumptions changes
marginal propensity to consume
change in C when disposable income increases by one dollar
investment function
I = I(r)
where r denotes the real interest rate (cost of borrowing)
- so as real interest rate increases, investment decreases
- spending on investment goods depends negatively on the real interest rate
government spending
government spendong on goods and services
- excludes transfer payments
- assume government spending and total taxes are fixed or determined by the ole gvt
aggregate demand formula
C(Y-T) + I(r) + G
aggregate supply
Y = F (K,L)
equilibrium for the market for goods and services
Y = C(Y-T) + I(r) + G
real interest rate adjusts to equate demand withs supply
loanable funds market
- simply supply-demand model for the financial system
- one asset: “loanable funds”
- -demand for funds: investment
- -supply of funds: saving
- -“price of funds”: real interest rate
demand for funds
INVESTMENT
- firms borrow to finance spending on plants and equipment, new buildings
- consumers borrow to buy new houses
-depends negatively on the real interest rate (r)
supply of funds
SAVINGS
- savings come from households and government
- households use thier saving to make bank deposits, purchase bonds, and other assets
- the government may also contribute to saving if it does not spend all the tax revenie it receives
formulas for: private saving public saving national saving total saving
private saving = (Y-T)-C, Sp public saving = T - G, Sg national saving = S = Sp + Sg =private saving + public saving S = (Y - T) - C + T - G S = Y - C - G
budget surpluses and deficits
budget surplus if T > G
budget deficit if T < G
balanced budget if T = G
finanace deficits by issuing Treasury Bonds
loanable funds market: axis’ and demand and supply
Y axis: r
X axis: S, I
supply curve: loanable funds, vertical because national saving does not depend on r
demand curve: downward sloping
things that shift the savings curve
public saving: fiscal policy changing G or T private saving: preferences tax laws that affect saving -401 K IRA -replace income tax with consumption tax
thigns that shift the investment curve
- technological innovations
- to take advantage of innovations, firms must buy new investment goods - tax laws that affect investment
- investment tax credit
what happens to the interest rate and the equilibrium level of investment when there is an increase in desired investment?
demand curve shifts right
-shows an increase in the interest rate but level of investment cannot increase because supply of loanable funds is fixed
Reagen Deficits explanation
policies increased government spending while giving massive tax cuts
-both policies reduce national saving
the increase in the deficit reduces savings, which causes real interest rates to rise, which reduces the level of investment
quantity equation of money
M x V = P x Y
M = money supply Y = output P = price of one unit of output V = velocity of money
assumptions of quantity equation of money
-V is fixed, Y is fixed
implies that any percent change in M = change in P (inflation)
quantity theory of money for a fixed level of income
percentage change in money supply = the inflation rate
- a one percent increase in the money supply causes a one percent increase in inflation
- the Fed, which controls the MS, has the ultimate control over the rate of inflation
implications of quantity theory
- countries with higher money growth rates should have higher inflation rates
- long-run trend behavior of a country’s inflation should be similar to the long-run trend in the country’s money growth rate