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NEK 203 > Föreläsning 5-13 > Flashcards

Föreläsning 5-13 Flashcards

1
Q

Why is it important to understand what determines consumption?

A

Saving = income minus consumption, so we can consume in the future.
Long term
Closed economy: Saving effects the investments and thus capital stock and thus the income level
Open economy: Saving affects the current account and foreign debt and thus the income level

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2
Q

What is the relationship between consumption and GDP in the short term?

A

Consumption is the largest component of demand, accounting for approximately 50% of GDP, and varies roughly as much as GDP itself. Meaning consumtion growth will follow GDP growth.

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3
Q

What does the consumer’s budget constraint consist of in a two-period model?

A

Saving = income minus consumption, i.e., A2 = Y1L - C1 (Income in period one minus consumption in period 1)
and Consumption in the next period: C2 = Y2L + A2 + rA2. (Income plus savings and the interest rate of those savings)
From the two expression we can derive a budget constraint for the whole lifetime (period 1 and 2)

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4
Q

How does consumption in period 2 depend on period 1 consumption?

A

If the consumer consumes one unit more in period 1, consumption in period 2 must decrease by 1+r units.

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5
Q

What does the slope of the budget line represent?

A

The slope is -(1+r), indicating the trade-off between consumption in period 1 and period 2.

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6
Q

What is the utility function for a consumer in intertemporal preferences?

A

U(C1, C2) = u(C1) + u(C2) / 1 + ρ.

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7
Q

What does a high subjective discount rate (ρ) indicate about the consumer?

A

The consumer is impatient and cares little about the future.
We assume that ρ > 0, meaning the consumer values consumption today more than consumption in the future.

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8
Q

What is the optimal consumption choice condition?

A

The slope of the budget line equals the marginal rate of substitution (MRS).
When the indifference curve is tangent to the budget line.

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9
Q

What happens when the real interest rate increases for a net saver?

A

Higher interest rates make savings more attractive, leading to lower consumption now and higher in the future.

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10
Q

Explain the substituation effect of an interest rate increase in a net saver (Y > C1)

A

Higher interest rate makes savings more attractive: lower consumption now, higher in the future

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11
Q

Explain the income effect of an interest rate increase in a net saver (Y > C1)

A

Higher interest rate makes the consumer richer: higher consumption both now and in the future, assuming the consumer is a net saver from the beginning (borrower: lower consumption both now and in the future)

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12
Q

What is the implication of the permanent income hypothesis?

A

Consumption is only affected by changes in permanent income.

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13
Q

Define the natural real interest rate (rn).

A

Where aggregate demand equals natural output.

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14
Q

What does the Fisher equation represent?

A

i = r + π, indicating the relationship between nominal interest rates and inflation. higher inflation leads to higher nominal interest rates

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15
Q

What are the factors determining the consumption function?

A
  • Current income, Y
  • Expected future income, Ye
  • Real interest rate, r
  • Assets, A.
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16
Q

What is the effect of a decrease in the subjective discount rate (ρ’)?

A

Households want to save more, leading to higher capital accumulation.

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17
Q

What is the balanced growth path in the context of population growth and technological development?

A

K and Y grow at a constant rate while k and y remain constant.

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18
Q

What is the relationship between income and consumption growth?

A

Income and consumption will grow at the same rate.

This implies that as the economy grows, both income and consumption increase proportionally.

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19
Q

What is the equation that relates the real interest rate to the subjective discount rate and technological development?

A

1 + g = 1 + rt / 1 + ρ → ȓ ≈ ρ + g

This equation shows the approximation of the real interest rate based on the subjective discount rate (ρ) and the growth rate (g).

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20
Q

What happens when r = ρ?

A

Consumers want to borrow today to consume the same amount today as in the future.

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21
Q

What does it mean when r = ρ + g?

A

The interest rate is high enough for consumers to accept consuming less today relative to the future.

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22
Q

What is the equilibrium condition denoted as k*?

A

k* represents the steady state of capital per effective worker.

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23
Q

What role does capital accumulation play in economic growth?

A

Capital accumulation plays a central role in economic growth.

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24
Q

What factors are necessary for long-term growth?

A

Population growth and/or technological development.

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25
What happens to the marginal product of capital (MPK) as more capital is added?
The marginal product of capital decreases as we add more capital for given N and E.
26
What is a steady state in economic terms?
A stable growth path where capital and production per effective worker are constant.
27
What does the theory of convergence suggest about income disparities?
Income differences should even out over time.
28
Under what condition should poorer countries catch up with richer ones?
If two countries have the same E, 𝛿, ρ, µ, un, the poorer country should have higher growth and catch up.
29
What are the factors that affect GDP per capita according to the model?
Differences in Y/N depend on: 𝛿, ρ, µ, un, E.
30
What types of capital are recognized in economic models?
* Physical capital * Private capital * Public capital * Human capital
31
How much of the differences in income between countries can be explained by capital?
Approximately 10-30% of income differences between countries are explained by differences in capital.
32
What is one measure of human capital?
The average number of years of schooling for the adult population.
33
What is the relationship between human capital and income differences between countries?
Approximately 20% of income differences can be explained by differences in human capital.
34
What is the role of technological development in economic growth?
Technological development drives growth and affects production possibilities.
35
What is sustainable growth?
Historically we observe that countries have experienced sustained growth,, some countries catch up with the richest, some don't, and we have discussed how we can explain these observations based on the model The model captures much of the historical development Sustainable growth = growth that has been maintained over a long time Looking ahead, we know that the world's economies face significant challenges: climate transition and finite resources To describe sustainable growth ahead, these factors need to be considered.
36
Why is it important to understand unemployment
Unemployment means that total production and income are lower than they could be Unemployment is a cause of poverty, inequality and social problems
37
What are the two types of unemployment?
* Equilibrium unemployment (natural rate of unemplyment, long term) * Cyclical unemployment
38
What is the labor force defined as?
L = N + U, where N is the number of employed and U is the number of unemployed.
39
What does the unemployment rate (u) represent?
u = U/L, the unemployment rate as a share of the labor force.
40
What influences the chances of getting a job for job seekers?
Factors include the number of job vacancies, the number of job seekers, and the unemployment rate.
41
What is the probability of finding a job (f)?
f = Ns + NZf / (λU + sN + NZ) = s/(λu +s)
42
What is the effect of high unemployment on the job finding rate?
Increased unemployment makes it more difficult to find a job.
43
What is the relationship between supply and demand in the labor market?
Unemployment occurs when the supply of labor exceeds the demand for labor.
44
Why does equilibrium unemployment occur? (4 theories/factors)
Efficiency wages (set a wage higher than clearing wage) Search frictions and matching problems (not everyone is identical and it can take time to make a good math Labor unions Minimum wages
45
What are efficiency wages?
Wages set higher than the clearing wage to reduce employee turnover.
46
What is the total cost for a firm's workforce?
Total cost = direct wage cost + turnover cost.
47
What happens to turnover costs if wages increase?
Turnover costs decrease as higher wages reduce employee turnover.
48
What is the natural unemployment rate (un)?
The only level of unemployment where all firms set the same wage is the natural unemployment rate.
49
What is the wage-setting equation?
Wd = W + a(u - un) ## Footnote Where Wd is the desired wage, W is the average wage, and u is the unemployment rate.
50
What is the dynamic wage-setting equation?
Desired wage growth depends on average wage growth and cyclical unemployment.
51
What is the relationship between matching problems and unemployment?
There are more reasons for unemployment to occur and influence wage-setting. Now: matching problems and search frictions - Workers and jobs are different - Often, it takes time for an unemployed worker to find a job, and for a firm to find a person to hire - If the matching process takes time, it results in search unemployment
52
What does N represent in the equation N + U?
N represents the number of employed individuals ## Footnote N is calculated as L(1 - u), where L is the labor force and u is the unemployment rate
53
What factors affect search unemployment?
* How actively the unemployed are searching for jobs * How selective the unemployed are in job applications * How well the unemployed can compete for jobs
54
What is the search intensity (λ) in relation to unemployment?
Search intensity (λ) is the proportion of the unemployed who actively search for a job, where 0 < λ ≤ 1
55
How does a decrease in search intensity (λ) affect unemployment?
It increases the chance of getting a job, leading to optimal wage increases and higher unemployment
56
What is the role of unions in wage-setting?
Unions negotiate wages higher than what firms would prefer, which can lead to higher unemployment if the union mark-up is greater than zero
57
What happens when the union mark-up is greater than zero?
The wage-setting curve shifts outward, potentially increasing unemployment in the short term
58
What is the impact of minimum wages on employment?
High minimum wages can lead to higher unemployment if it is no longer profitable for companies to hire as many workers
59
What is meant by 'skill-biased technical change'?
Technological advancements that favor highly educated individuals, which can exacerbate unemployment for those with lower skills
60
Money is an asset defined by its functions. What functions does money serve?
Means of transactions: We use money for payments, and the need for money depends on the volume of transactions. Unit of Account: Prices and wages are set in terms of money. Store of Value (non-interest-bearing form): Interest is, therefore, the opportunity cost of holding money. Central Bank Controls the Money Supply: The central bank determines the supply of money in circulation.
61
What determines the demand for money?
Demand for money is determined by the equation M * V = P * Y
62
Define the monetary base (M1).
Monetary base includes currency and coins in circulation plus banks’ deposits with the central bank
63
What is the relationship between the quantity of money and nominal GDP?
The quantity of money times its velocity equals nominal GDP
64
How does a constant velocity (V) affect the demand for money?
Demand for money increases with the price level and GDP, and decreases with velocity
65
What is the equilibrium condition for money supply and demand?
M/P = Y/V(i)
66
What occurs in the long term when the central bank increases the money supply?
In the long term, the price level increases
67
What does seigniorage refer to?and why does it happen?
Seigniorage is the profit generated when the central bank creates money. Growth rate of real GDP (incomes): if g+n increases, demand for the monetary base increase (need money to be able to trade) Inflation: if π increases, the real value of money decreases, which means that the money supply (nominal) must increase, called the inflation tax
68
What is the inflation tax?
Inflation tax refers to the reduction in the real value of money, requiring an increase in the nominal money supply
69
List some problems associated with high inflation.
* Menu costs * Harder price comparisons * Unexpected wealth redistributions * Complications in long-term decisions
70
What are the effects of too low inflation?
It complicates real wage adjustments and monetary policy
71
What is the optimal inflation target for most central banks?
High inflation causes significant costs Inflation close to zero can lead to problems It’s difficult to determine the exact optimal inflation rate Most central banks have inflation targets around 2%
72
In the IS-LM model, what does IS represent?
IS represents equilibrium in the goods market
73
What does LM stand for in the IS-LM model?
LM stands for equilibrium in the money market
74
What happens to production when the interest rate rises?
Higher interest rates lead to lower demand and production
75
What is the total effect of an increase in investment (I) on production?
The total change in production is calculated using the multiplier effect
76
What does the LM curve illustrate?
The relationship between production and interest rates, given money supply and price level
77
What happens when the central bank increases the money supply?
Lower interest rates result, which increases demand for loans
78
What is the effect on interest rates when GDP increases?
Interest rates rise due to increased transactional demand for money
79
What happens to the demand for money when it increases?
The curve shifts outward ## Footnote This indicates households demand higher compensation to lend money.
80
How do higher interest rates affect borrowing by firms?
Firms must offer higher interest rates to borrow ## Footnote This is due to increased demand for money.
81
What results in movement along the LM curve?
Changes in Y and i ## Footnote Y represents income and i represents interest rates.
82
What shifts the LM curve?
Changes in M or P ## Footnote M is the money supply and P is the price level.
83
What is the consumption function in the IS-LM model?
C = C(Y, Ye, i - 𝜋e, A) ## Footnote C is consumption, Y is income, Ye is expected income, i is interest rate, 𝜋e is expected inflation, and A is other factors.
84
What is the investment function in the IS-LM model?
I = I(i - 𝜋e, Ye, K) ## Footnote I is investment, and K represents capital.
85
What is the goods market equilibrium equation in the IS-LM model?
Y = C(Y, Ye, i - 𝜋e, A) + I(i - 𝜋e, Ye, K) ## Footnote This equation balances consumption and investment.
86
What is the money market equilibrium equation in the IS-LM model?
M/P = Y/V(i) ## Footnote M is money supply, P is price level, Y is income, and V(i) is velocity of money.
87
What are the four endogenous variables in the IS-LM model?
* Y * C * I * i ## Footnote These are determined by the four equations in the model.
88
What happens when the money supply increases?
Interest rates decrease, and production increases ## Footnote More money available for lending leads to increased investment and consumption.
89
What occurs when optimism about future incomes increases, keeping M constant?
C and I increase, shifting the IS curve outward ## Footnote This results in increased aggregate demand and production.
90
What happens to interest rates when aggregate demand increases due to optimism about future incomes?
Interest rates rise ## Footnote This is because the demand for money for transactions increases.
91
What happens if optimism about future income increases while keeping i constant?
IS shifts outward, and LM shifts to accommodate increased transaction volume ## Footnote Production increases while the interest rate remains unchanged.
92
What results from increased production and demand due to optimism about future income?
Employment increases ## Footnote More workers are needed to produce more goods.

NEK 203 (7 decks)

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