Macro Flashcards
What is the difference between real and nominal GDP?
Which is best for measuring development in output?
Real = measured at constant prices Nominal = measured at current prices
If real GDP increases it is due to an increase in output only, whereas an increase in nominal GDP can also be due to price increases.
Which 4 elements is summed in GDP?
Consumption, Investment, Government spending, Net exports
What is measured by the CPI?
CPI is the Consumer Price Index
It measures the price of a fixed basket of goods.
The CPI measures the overall price level
What is measured by the unemployment rate?
It shows the fraction of those who are willing to work, but do not have a job.
Classical theory
What determines the economy’s output?
The output is determined by two factors:
1) Factors of production (labor and capital)
2) Technology
Increase in one of these = increase in output
Classical theory
What determines the amount of labor hired by a profit-maximizing firm?
A profit-maximizing firm will hire workers until:
MPL = W/P
MPL expresses the extra output gained by hiring an extra worker
W/P expresses the real wage
When the extra output equals the cost of that output, that is when the firm will stop hiring workers, as the added cost will exceed the added revenue.
Classical theory
What determines the amount of capital hired by a profit-maximizing firm?
A profit-maximizing firm will hire workers until:
MPK = R/P
MPK expresses the extra output gained by hiring an extra unit of capital
R/P expresses the real rent of capital
When the extra output equals the cost of that output, that is when the firm will stop hiring workers, as the added cost will exceed the added revenue.
Classical theory
What is the economy’s output used for?
It is used for:
- Consumption (positively dependent on disposable income)
- Investments (negatively dependent on the real interest rate)
- Government spending and taxes (exogenous)
Classical theory
What happens if national savings decrease? And what could causes be?
It could be caused by an increase in government spending or a decrease in taxes
It would reduce the amount of investment, moving the savings curve to the left. This will increase the interest rate.
Classical theory
What happens to the interest rate as an effect of an increase of taxes?
Tax increases will increase national savings.
As S = I the savings curve will shift to the right, thus lowering the interest rate.
Classical theory
What is the production function?
Y = F(K,L)
Classical theory
How is national income distributed?
National income is distributed into capital income and labor income:
Capital income = MPK * K
Labor income = MPL * L
It can be written as Cobb-Douglas:
Y = A K^a L^(1-a)
In this case:
Capital income = aY
Labor income = (1-a)Y
If a = 0.5 then the national income if evenly divided
What is MPC?
MPC = Marginal Propensity to Consume
It is the amount by which consumption increases when disposable income increase by 1€
There are diminishing returns, which means that if the disposable income is already high (e.g. Western countries) the consumption will no go up as much as in poorer countries (e.g. Africa)
What is fiat and commodity money?
Fiat: Money without any intrinsic value (e.g. coins)
Commodity: Money with intrinsic value (e.g. gold)
What are the three main purposes of money?
Store value: we can transfer purchase power
Unit of account: we can quote prices and debt in terms of money
Medium of exchange: we can use it to buy goods and service
Which three instruments does the central bank have for monetary policy?
1) Perform open-market operations, where it buys/sells bonds to increase/reduce the monetary base.
2) Lower/increase the refinancing rate to increase/reduce the monetary base.
3) Reduce/increase the reserve-deposit ratio by relaxing/tightening reserve requirements
Write up the model for money supply
The model is:
M = m * B
where m is the money multiplier and B is the monetary base.
m = (cr + 1) / (cr + rr)
What happens to the money multiplier if rr < 1?
Then m > 1 as the top is larger than the bottom of the equation
Monetary theory
Which factors does the money supply depend upon?
Money supply depends on:
1) Preference to hold currency (rr)
2) Regulation of deposit to reserve ratio (cr)
3) The monetary base (B)
What effects will an increase of 10% in the monetary base have on the money supply?
▲M = m * ▲B
Hence, a 10 % increase in B will lead to a 10 % increase in M
Explain what a lower reserve-deposit ratio (cr) will have on M
It will mean that the bank can do more loans and thereby create more money for each euro of reserve
= m will increase
= M will increase
Explain the effects of a lowered currency-deposit ratio (rr) on the M
It will mean that there are fewer euro being held as curreny, hence more deposits are made.
With larger deposits banks are able to lend out more money
= m will increase
= M will increase