Exam 3 Flashcards
information asymmetry problems
- adverse selection problems
- moral hazard
adverse selection problems (information asymmetry)
- increases the probability that a potential borrower is a bad credit risk
- lenders may refuse loans even when good credit risks exist in financial markets
differentiating bad from good credit risks
difficult and costly
moral hazard (information asymmetry)
- when a borrower engages in activities that are undesirable from the perspective of the lender
moral hazard can also be called
agent problems or agency problems
agents and principals
- stock brokers for their clients
- investment bankers for firms whose stock offerings they underwrite
- CEOs for a corporations shareholders
when do adverse selection problems occur
- before transactions occur
when do moral hazard problems occur
- they exist because there is a problem monitoring behavior after a transaction is already under way
adverse selection can lead to
credit rationing
how do bad credit risks effect interest rate
bad credit risks are interest rate inelastic
financial intermediarys
are important for solving information asymmetry problems and bringing savers and investors together
ex. commercial and investment banks
ex. stock and bond exchanges
% GDP relative to financial markets: Highest
switzerland
% GDP relative to financial markets: Lowest
ecuador
business cycle expansions
GDP grows faster than average
business cycle recessions
GDP growth becomes negative
what are business cycles
- variation in actual output relative to potential output
- short run changes in potential output
- which one depends on if we believe Say’s law is true or not
Say’s Law
- supply creates its own demand
John Maynard Keynes
- in the long run we are all dead
- Say’s Law: products always exchange for products
- money is an important intermediary but can create problems
- produce a good -> get money -> buy goods
why may prices or their growth rates be sticky
- there are physical costs associated with changing prices
- there are costs associated with informing customers about price changes (advertising)
- coordination problems can exist across competitors (pepsi & coke)
- nominal price increases upset customers (gas prices)
- unions can build nominal wage stickiness into wage contracts
aggregate demand
- combinations of inflation and real growth that are consistant with a specific rate of spending growth
equation
%∆M + %∆V = %∆P + %∆Y
money supply, velocity, price level, real growth
spending growth = inflation + real growth
%∆M + %∆V
spending growth
%∆P + %∆Y
inflation + real growth
higher inflation rates yield
lower real growth rates
lower inflation rates yield
higher real growth rates
menu costs
if you want to change the menu then you have to buy all new menus. its not as simple as saying you have lower prices
aggregate demand graph
relates peoples spending behavior to possible rates of inflation and real growth
spending in the aggregate
must be consistent with how many good firms can and are willing to produce
long run aggregate supply (LRAS)
- solou growth curve
- represents the growth rate of potential output (what firms can sustainably produce)
short run aggregate supply (SRAS)
- represents what firms are willing to produce
determine the sustainable long run growth for the economy
- institutional quality
- technology change
- investments
real “productivity” shocks
an unexpected change in the solou growth rate
aggregate demand “nominal” shocks
unexpected changes in the spending growth rate
π
inflation
y axis
g
real growth rate
x axis
every nominal spending growth rate has some inflation rate that is consistant with
the solou growth rate
what if that particular inflation rate doesnt occur
- then spending growth will be greater or less than the real potential growth rate
- firms will want to produce consistent with actual spending growth
if prices are sticky
then short run aggregate supply (SRAS) will be different than long run aggregate supply (LRAS)
sluggish adjust
the short run is separated from the long run by the extent to which prices are sticky
what determines the real potential growth rate
- institutions
- technological progress
- increase in capital per worker
changes in spending growth in the short run
lead to changes in both %∆P and the real growth
Keynes on recessions
recessions correspond to increases in money demanded
3 things people do with income
- spend it on goods
- make loans to others who spend it on goods
- hold onto it as money
if prices do not adjust
spending growth can fall short of potential real growth
if prices adjust fully
the economy can get back to potential growth and eventually will
Keynesian type recession story
assume that consumers and firms become pessimistic about the future (their animal spirits become negative) %∆V decreases
people hold on to more money %∆C and %∆I decreases
long run of Keynesian type recession
in the long run prices will adjust to this negative nominal shock
In the long run we are all dead
why would prices remain sticky for so long while unemployment is high
policies that point to long run stickiness
- minimum wage laws
- union wage contracts
can animal spirits and sticky prices account for the great depression
- sticky prices during 4 years of falling incomes and peak unemployment of 25%
- federal reserve decreased the money supply
- Smoot - Hawley Tariff put in place june 1930 which raised tariffs on 20,000 types of imported goods
