Macro Flashcards
What is money illusion? to
money illusion is
dpe/dp not being equal to 1.
pe is expected price. p is actual price level.
When do people suffer from money illusion?
In the short run where dPe/dP < 1. (usually)
In the long run, dPe/dP = 1.
The long run case corresponds to the classical Economics framework.
The short run case is the Keynesian framework.
What is Kuznets consumption function?
It is a long run consumption function where autonomous consumption is 0.
mpc = apc
in keynes’s consumption function (Short run)
apc > mpc
what is stagnation thesis?
C + I + G = Y
C/y + I /Y + G/Y = 1.
In the short run APC is falling and I/Y is assumed to be constant. Thus G/Y must rise to support an equilibrium rise in Y.
Thus govt. spending has to increase more than income to support growth in the economy.
In multi period utility maximising problems (intertemporal) how does an increase in income/expected income in any period affect consumption in other periods?
An increase in income in any period will raise consumption across ALL periods, provided consumption in any period is not an inferior good.
this can be shown mathematically.
Multi period consumption decision
Say discount rate of consumption of future periods is x.
thus present value of C(t) = C(t)/ [(1+x)^t]
say interest rate is r. such that if he saves S in this period he gets S(1+r) in the next period.
If r>x, he will sacrifice present consumption for future consumption and C(t) will increase in every period. He will consume less than he earns and save.
if r
Multi period consumption decision 2
if r
Pigou wealth effect
Assets/Wealth is a decreasing function of price, P & r, interest rate.
Consumption increases with rise in Assets.
savings falls with rise in Assets.
A price fall causes IS curve to shift rightward.
inclusion of wealth effect makes the IS and aggregate dd curve flatter.
What are assets?
real value of assets Assets are = B/Pr + K/P + R/P
B - Total value of Bonds K - Total capital stock R - Reserve cash held by central bank. P- price r - interest rate
Increase in assets mean rise in consumption and fall in savings.
open market operations do not affect assets. As change In B is equal and opposite to change in R.
Does wealth effect help or hinder monetary/fiscal policy?
Inclusion of wealth effect makes monetary policy more effective but fiscal policy less effective compared to when wealth effect is ignored
What is gross investment? What is net investment?
net investment = K(t) - K(t-1)
gross investment = net investment + depreciation in t-1 period.
How is investment demand related to expected inflation?
P * MP (k) = user cost of capital.
User cost of capital = interest rate + depreciation rate - expected inflation.
if exp inflation rises, MP (k) has to fall. Thus K has to rise since decreasing returns to a factor. Thus demand for investment rises.
Velocity of money ?
Velocity of money is 1/k
It increases with an increase in interest rate and expected inflation.
If Money demand is written separately as kY + L(r), then k and hence v are constant.
However if we use quantity theory of money where Money demand (M/P) = kY. Then k is a decreasing function of r & expected inflation.
Tobin Baumol demand for money
According to Tobin and Baumol
Money dd = (aY/2rT)^1/2
a = cost of transactions
T = the time period in which GDP is Y. It’s equal to 1 if Y given is for the time To.
Say, We get 300 rupees In 1 year, then while calculating money demand for the year, Y = 300, T = 1
Money demand falls with rise in expected inflation and interest rate.
What is Monetarist policy?
Monetarist economists believe Money demand does not depend on interest rate. Therefore for them, LM curve is a vertical line.
