Macro Flashcards

1
Q

What is the difference between real and nominal GDP?

Which is best for measuring development in output?

A
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.

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2
Q

Which 4 elements is summed in GDP?

A

Consumption, Investment, Government spending, Net exports

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3
Q

What is measured by the CPI?

A

CPI is the Consumer Price Index
It measures the price of a fixed basket of goods.
The CPI measures the overall price level

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4
Q

What is measured by the unemployment rate?

A

It shows the fraction of those who are willing to work, but do not have a job.

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5
Q

Classical theory

What determines the economy’s output?

A

The output is determined by two factors:

1) Factors of production (labor and capital)
2) Technology

Increase in one of these = increase in output

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6
Q

Classical theory

What determines the amount of labor hired by a profit-maximizing firm?

A

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.

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7
Q

Classical theory

What determines the amount of capital hired by a profit-maximizing firm?

A

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.

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8
Q

Classical theory

What is the economy’s output used for?

A

It is used for:

  • Consumption (positively dependent on disposable income)
  • Investments (negatively dependent on the real interest rate)
  • Government spending and taxes (exogenous)
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9
Q

Classical theory

What happens if national savings decrease? And what could causes be?

A

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.

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10
Q

Classical theory

What happens to the interest rate as an effect of an increase of taxes?

A

Tax increases will increase national savings.

As S = I the savings curve will shift to the right, thus lowering the interest rate.

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11
Q

Classical theory

What is the production function?

A

Y = F(K,L)

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12
Q

Classical theory

How is national income distributed?

A

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

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13
Q

What is MPC?

A

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)

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14
Q

What is fiat and commodity money?

A

Fiat: Money without any intrinsic value (e.g. coins)

Commodity: Money with intrinsic value (e.g. gold)

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15
Q

What are the three main purposes of money?

A

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

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16
Q

Which three instruments does the central bank have for monetary policy?

A

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

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17
Q

Write up the model for money supply

A

The model is:
M = m * B

where m is the money multiplier and B is the monetary base.

m = (cr + 1) / (cr + rr)

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18
Q

What happens to the money multiplier if rr < 1?

A

Then m > 1 as the top is larger than the bottom of the equation

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19
Q

Monetary theory

Which factors does the money supply depend upon?

A

Money supply depends on:
1) Preference to hold currency (rr)

2) Regulation of deposit to reserve ratio (cr)
3) The monetary base (B)

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20
Q

What effects will an increase of 10% in the monetary base have on the money supply?

A

▲M = m * ▲B

Hence, a 10 % increase in B will lead to a 10 % increase in M

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21
Q

Explain what a lower reserve-deposit ratio (cr) will have on M

A

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

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22
Q

Explain the effects of a lowered currency-deposit ratio (rr) on the M

A

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

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23
Q

Which assumptions are made in the Quantity Theory of Money?

A

It assumes that velocity is fixed and that factors of production determines the output.
This means that both V and Y is fixed in the model.

24
Q

Explain the Fisher effect

A

The Fisher effect is:
i = r * pi

with

  • i = nominal interest rate
  • r = real interest rate
  • pi = inflation

The Fisher effect is that 1 % increase in rate of money growth = 1 % increase in inflation = 1 % increase in nominal interest rate

25
Q

Explain the Quantity Theory of Money

A

M * V = P * Y

26
Q

Explain the money demand function

A
(M/P) = L(i,Y) or
(M/P) = L(r+exp. pi , Y)

M/P depends:

  • Negatively on i/r
  • Positively on Y
27
Q

What are the costs of inflation?

A

Shoe-leather cost: inconvenience of going to the bank

Menu cost: cost of changing menus due to price changes

Insufficient resource allocation: resources are not allocated correctly when prices change

28
Q

Explain inflation as a wage cut

A

If inflation goes up by 2 % each year, then workers real wages go down by 2 %. In that way, inflation ensures that wages are kept down.

29
Q

What is net exports?

A

The difference between imports and exports.

30
Q

How does national savings differ between an open and a closed economy?

A

Open: S - I = 0
Closed: S - I = NX

31
Q

What are the assumptions of the neoclassical model for small open economies?

A

1) Domestic and foreign bonds are perfect substitues
2) There is perfect capital mobility
3) The economy is small (r = r*)

This means that r = r* and that r* is exogenously given

32
Q

Neoclassical model:

What happens is the real exchange rate goes up=

A

Increase in the real exchange rate means that domestic goods become more expensive relative to foreign goods.

This drives down EX and increases IM, which means that NX will go down

33
Q

Explain the equation for the real and nominal exchange rate

A

Real:
Epsilon = e * (p/p*)

Nominal:
e = epsilon * (p*/p)

Another way to put it is in terms of growth rates:
Change e = change in epsilon + foreign inflation - domestic inflation

34
Q

What happens to the nominal exchange rate from A to B, if real exchange rate is kept constant, prices in country A increases by 4 % and prices country B increase by 8 %?

A

This means that:
1) Change in real exchange rate = 0

2) Inflation A = 4 %
3) Inflation B = 8 %

▲e = ▲epsilon + pi(B) . pi(A)

▲e = 0 + 8 % - 4 % = 4%

35
Q

What is the natural rate of unemployment? In a recession, will it be higher/lower than actual unemployment?

A

It is the average rate of unemployment around which the economy fluctuates.

In a recession, the actual unemployment rate is high and will be above the natural rate of unemployment.

36
Q

Describe the steady-state condition for unemployment

A

s * E = # of employed people who lose their jobs

f * U = # of unemployed people who find jobs

Steady-state:
sE = fU

37
Q

How can the natural rate of unemployment be found?

A

The steady-state condition can be re-written as:

U/L = s / (s+f)

38
Q

What is frictional unemployment?

A

Unemployment due to the time it takes to search for a job

Occurs when wages are flexible and there are enough jobs

Can be due to:

  • Different abilities or preferences
  • Skill requirements
  • Geographic mobility takes time
39
Q

What is structural unemployment?

A

The unemployment caused by wage rigidity and job rationing

This can be due to three things:

1) Minimum wage laws
2) Labour unions
3) Efficiency wages

40
Q

What is the effect on an increase in unemployment insurrance?

A

An increase in UI reduces the opportunity cost of being unemployed, as the income difference between employment and unemployment shrinks.

This means that people are not searching for a jobs as intensively as earlier, hence f is reduced.

The frictional unemployement goes up.

41
Q

Solow growth model:

What is the steady state condition of the Solow growth model?

A

The steady state occurs when:
▲k = sf(k) - δk = 0

This can be written as:
sf(k) = δk

Hence, where savings equal break-even investments

42
Q

Solow growth model:

What is the golden rule steady state, and how can it found?

A

The golden rule steady state (k*-gold) is the steady-state value of k that maximizes consumption

It can be found where:
MPK - δ = 0 or
MPK = δ

The consumption per worker at that level is then:
c* = f(k) - δk

43
Q

Solow growth model:

If MPK > δ, what does this say about our k?

A

MPK > δ means that we have to little capital, which is why MPK is large.

To increase consumption we should increase capital stock, which would decrease MPK to a point where:
MPK = δ

44
Q

Solow growth model:
When having too much capital, what can be done to end at the Golden Rule steady-state?
What are SR and LR effect?

A

When having too much capital, hence MPK < δ, then the capital stock can be reduce through a reduction in the savings rate.

SR: 
The SR effects are:
- Decrease in Y
- Decrease in I
- Increase in C

LR:
Due to a decrease in Y and I, the capital stock of the economy will drop, hence Y will go further down and the increase in C will slowly be offset (but larger than before reducing the savings rate)

45
Q

Solow growth model:

What is the law of motion in k and the steady-state condition when taking population growth into account?

A

When taking population growth into account, we need to be able to provide capital for the new workers.

This means that the break-even investment become:
(δ+n)k

The law of motion in k:
▲k = sf(k) - (δ+n)k

The steady-state is:
sf(k) = (δ+n)k

The golden rule is:
MPK - δ = n or
MPK = δ + n

46
Q

Solow growth model:

If the economy has too little capital (MPK > δ), what would then happen to consumption is the savings rate is increase?

A

In the short run, the consumption would go down to be able to save more.

The higher savings will increase capital stock, moving the economy towards the golden steady-state.

In the long ron, Y will increase due to increase in capital stock, hence C will increase.

SR: C will go down
LR: C will go up above the initial level due to increase in Y

47
Q

What is the tax multiplier?

A

▲T * (MPC / (1-MPC))

48
Q

What is the government spending multiplier?

A

▲G / (1 - MPC)

49
Q

How can the central bank change the money supply in practice?

A

Open-market operations:
Buy/sell bonds

Refinancing rate:
The interest rate charged to the banks

Reserve requirements:
How much money must a bank have as reserves

50
Q

True/false: Automatic stabilizers stabilize the government budget balance through the business cycle.

A

False. Automatic stabilizers stabilize disposable income among households through economic cycles, but destabilize the public budget balance.

51
Q

True/false: In the Solow model the steady-state growth rate in consumption per worker depends on the savings rate, s.

A

False. The growth rate of consumption per worker is given by the growth rate of technology (E), which is exogenous and equal to g, and thus independent of the savings rate s.

52
Q

True/false: A higher population growth rate, n, increases the golden rule capital stock per worker (k*gold) in the Solow model (assume for simplicity that g = 0).

A

False. A larger population growth decreases k* gold because the break-even investment curve becomes steeper. (Note also that k* gold is implicitly defined by MPK = n +  + g = n + . Hence, a higher n implies a higher MPK for this equation to be fulfilled, which requires a lower capital stock.) See chapter 9. Intuitive: A larger population growth increases the ‘price’ to maintain a given amount of capital per worker and therefore the increase in the required investment outweighs the increase in output by raising the capital stock.

53
Q

True/false: Migration of workers from one country to another affects the natural level of output in either country.

A

True: Natural level is determined by factors of production, capital and labor, and a change in labor would affect the natural level of output.

54
Q

True/false: j) A basic assumption of the Solow model of economic growth is that the marginal returns to capital are constant regardless of the economy’s capital stock.

A

False: there is diminishing return to capital, as the higher capital you get, the lower effect it will have.

55
Q

True/false: b) Like the Consumer Price Index (CPI), the GDP deflator is based on a fixed basket of goods.

A

False: GDP deflator changes each year, and takes all goods into account.

56
Q

True/false: h) The sticky-wage model used to explain why the short-run aggregate supply curve is upward- sloping predicts a counter-cyclical real wage rate and is thus largely at odds with the evidence about the behavior of real wages through the business cycle.

A

True: when the economy is in boom, P increases, which decreases the real wage.