Macro Midterm 2 Flashcards
Productivity
explains why living standards vary so much from country to country, quantity of goods and services produced from each unit of labor
Determinants of productivity
physical capital (K/L), human capital (H/L), natural resources (N/L), and technological knowledge (A)
Physical capital
stock of equipment and structures used to produce goods and services ex. saws, drill presses
Human capital
knowledge and skills that workers acquire through education, training, and experience
Natural resources
land, rivers, mineral deposits, and other resources provided by nature and used as inputs into production -> renewable and nonrenewable
Technological knowledge
understanding of the best ways to produce goods and services
What is one way to raise future productivity?
devote more current resources to the production of capital
Diminishing returns
as the stock of capital rises, the extra output produced from an additional unit of capital falls
capital’s diminishing returns called diminishing marginal product of capital
Statement on the economy is the long run
the higher saving rate leads to a higher level of productivity and income but not to higher growth in these variables
Catch-up effect
Property of diminishing returns to capital implication: other things being equal, it is easier for a country to grow quickly if it start out relatively poor
Foreign direct investment
capital investment that is owned and operated by a foreign entity
Foreign portfolio investment
an investment financed with foreign money but operated by domestic residents
Externality
effect of one person’s actions on the well-being of a bystander
Brain drain
emigration of highly educated workers to rich countries, where these workers can earn more
Other than education what does human capital refer to?
expenditures that lead to a healthier population -> increases productivity and raises living standards
nutrition is one key factor
Another way policymakers can foster economic growth?
protecting property rights and promoting political stability
Property rights
ability of people to exercise authority over the resources they own, need to be respected for this process to work
threat: political instability -> economic prosperity depends in part on favorable political institutions
Inward-oriented policies
aim to increase productivity and living standards by avoiding interaction with the rest of the world
Outward-oriented policies
integrate these countries into the world economy, international trade in goods and services can improve economic well-being of a country’s citizens
Public good
once one person discovers an idea, it enters society’s pool of knowledge, and other people can freely use it
Financial system
consists of institutions that help match one person’s saving with another person’s investment
Large population and it’s affect on economy
large population means more workers are available to produce goods and services
Two categories of the financial system
financial markets and financial intermediaries
Financial markets
institutions through which a person who wants to save can directly supply finds to a person who wants to borrow
Bond market terms
bond: certificate of indebtedness that specifies the obligations of the borrower to the buyer of the bond
dat of maturity: time at which the loan will be repaid
principal: promise of interest and eventual repayment of the amount borrowed
term: length of time until the bond matures
Perpetuities: bonds that never mature
credit risk: probability that the borrower will fail to pay some of the interest or principal
default: failure to pay
tax treatment: way the tax laws treat the interest earned on it
Municipal bonds: bond owners are not required to pay federal income tax on interest income (may not need to pay state and local taxes either)
inflation protection: Treasury inflation-protected securities (TIPS) generally pay lower interest rate than similar ones without this feature
Stock market
stock: represents partial ownership in a firm and is a claim to some of the profits firm makes
equity finance: sale of stock to raise money
debt finance: sale of bonds
stock index: computed as an average group of stock prices
Financial intermediaries
financial institutions through which savers can indirectly provide funds to borrowers
Banks
primary job: take in deposits from people who want to save and use these deposits to make loans to people who want to borrow
medium of exchange: checks, electronic payment, debit card
store of value: wealth that people have accumulated in past saving
Mutual funds
institution that sells shares to the public and uses the proceeds to buy a selection, to portfolio, of various types of stocks, bonds, or both stocks and bonds
allow people with small amounts of money to diversify their holdings
funds give ordinary people access to the skills of professional money managers
index funds: buy all stocks in a stock index, perform somewhat better on average than mutual funds
Identity
equation that must be true because of the way the variables in the equation are defined
closed vs. open economy
closed: one that does not interact with other economies
open: interact with other economies around the world
closed economy GDP equation
Y = C + I + G
total income: (Y - C - G)
S = I -> S = Y - C - G or S = (Y - T - C) + (T - G)
National saving
total income in the economy that remains after paying for consumption and government purchases
Private saving
amount of income that households have left after paying their taxes and paying for their consumption
Y - T - C
Public saving
amount of tax revenue that the government has left after paying for its spending
T - G -> positive: surplus negative: deficit
Investment
refers to the purchase of new capital, such as equipment or buildings
Saving
depositing unspent income in a bank or using it to buy some stock or a bond from a corporation
Market for loanable funds
all savers deposit their saving in this market, and all borrowers take out their loans there
income people have chosen to save and lend out rather than use for their own consumption and to the amount that investors have chosen to borrow to fund new investment projects
Supply of loanable funds
saving is the source of the supply of loanable funds
Demand for loanable funds
investment is the source of the demand for loanable funds
Affect of higher interest rate
encourage saving (increasing the quantity of loanable funds supplied) and discourage borrowing for investment (decreasing the quantity demanded)
Impact of tax laws
reform of the tax laws encourages great saving, the result is lower interest rates and greater investment
Investment tax credit
tax reform aimed at making investment more attractive
gives tax advantage to any form building a new factory or buying a new piece of equipment
does not affect the supply of loanable funds
demand for loanable funds moves to the right
encourages greater investment, the result is higher interest rates and greater saving
Government debt and balanced budget
debt: accumulation of past government borrowing
balanced: government spending exactly equals tax revenue
Crowding out
government borrows to finance its budget deficit, crowds out private borrowers who are trying to finance investment
Affect of reducing national saving
when government reduces national saving by running a budget deficit, interest rate rises, and investment falls
long-run growth: government budget deficits reduce economy’s growth rate
Affect of budget surplus
increases the supply of loanable funds, reduces the interest rate, and stimulates investment
higher investment = greater capital accumulation and more rapid economic growth
Money
set of assets in the economy that people regularly use to buy goods and services from each other
Three functions of money
medium of exchange: item that buyers give to sellers when they purchase goods and services
unit of account: yardstick people use to post prices and record debts
store of value: item that people can use to transfer purchasing power from the present to the future
Wealth
total of all stores of value, including both monetary and non monetary assets
Liquidity
ease with which an assist can be converted into the economy’s medium of exchange
Commodity money
money takes form of a commodity with intrinsic vale
intrinsic value: item would hav value even if it were not used as money
Fiat money
money without intrinsic value
fiat: order of decree, and fiat money is established as money by government decree
Money stock
quantity of money circulating in the economy
currency: paper bills and coins in public hands
demand deposits: balances in bank accounts that depositors can access on demand simply by writing a check or swiping a debit card
Federal reserve
central bank designed to oversee the banking system and regulate the quantity of money
key determinants of inflation in the long run and employment and production in the short run
Dual mandate of the fed
stable prices and maximum sustainable employment
Lender of last resort
lender to those who cannot borrow anywhere else - to maintain stability in the overall banking system
Money supply and monetary policy
supply: fed controls the quantity of money available in the economy, closely connected to the level of interest rates
policy: setting of the money supply by policymakers in the central bank
Open-market operation
purchase and sale of US government bonds
Reserves
deposits that banks have received but have not loaned out
if banks hold all deposits in reserve, banks do not influence the supply of money
Fractional-reserve banking
banking system in which banks hold only a fraction of deposits as reserves
Reserve ratio
fraction of deposits that banks hold as reserves
determined by a combo of government regulation and bank policy
when banks hold only a fraction of deposits in reserve, banking system creates money
Reserve requirement
fraction of total deposits that a bank holds as reserves
Excess reserves
hold reservers above the legal minimum
Money multiplier
amount of money that results from each dollar of reserves
reciprocal of the reserve ratio
higher the reserve ratio, the less of each deposit banks loan out, and the smaller the money multiplier
Bank capital
resources that a bank obtains from issuing equity to its owners
Leverage and leverage ration
leverage: use of borrowed money to supplement existing funds for the purpose of investment
leverage ratio: ratio of the bank’s total assets to bank capital
Capital requirement
ensure that banks will be able to pay off their depositors (without having to resort to government-provided deposit insurance funds)
How the fed influences the quantity of reserves
open-market operations: buys or sells government bonds
fed lending to banks: banks borrow from the fed when they do not have enough reserves on hand either to satisfy bank regulators etc.
Discount rate
interest rate on the loans that the fed makes to banks
higher discount rate discourages banks from borrowing from the fed, decreasing the quantity of reserves in the banking system and, in turn, the money supply
How the fed influences the reserve ratio
reserve requirements: regulations on the minimum amount of reserves that banks must hold against deposits
interest on reserves: the interest rate paid to banks on the reserves held in deposit at the fed
Problems in controlling the money supply
fed does not control the amount of money that households choose to hold as deposits in banks
monetary controls is that the fed doesn’t not control the amount that bankers choose to lend
Federal funds rate
short-term interest rate that banks charge one another for leans
Inflation
increase in the overall level of prices
measured through percentage change in CPI
hyperinflation: extraordinary high rate of inflation
Deflation
where prices fall
What happens are price level rises
value of money falls
determined by supply and demand
Long-run: money supply and money demand
brought into equilibrium by the overall level of prices
Quantity theory of money
quantity of money available in an economy determines the value of money, and growth in the quantity of money is the primary cause of inflation
Effects of monetary injection
create an excess supply of money
increases demand for goods and services
Nominal variables
variables measured in monetary units
Real variables
variables measured in physical units
Monetary neutrality
the proposition that changes in the money supply do not affect real variables and affects nominal variables
Velocity of money
rate at which money changes hands
V = (P x Y) / M
P: price level
Y: quantity of output (real GDP)
M: quantity of money
Quantity equation
M x V = P x Y
Five points on the quantity theory of money
-The velocity of money is relatively stable over time.
-Because velocity is stable, when the central bank changes the quantity of money (M), it causes proportionate changes in the nominal value of output (P × Y).
-The economy’s output of goods and services (Y) is determined by factor supplies (labor, physical capital, human capital, and natural resources) and the available production technology. In particular, since money is neutral, money does not affect output.
-Because output (Y) is fixed by factor supplies and technology, when the central bank alters the money supply (M) and induces a proportional change in the nominal value of output (P × Y), this change is reflected in a change in the price level (P).
-Therefore, when the central bank increases the money supply rapidly, the result is a high rate of inflation.
Inflation tax
the revenue the government raises by creating money
inflation tax is like a tax on everyone who holds money
Real interest rate equation
real interest rate = nominal interest rate - inflation rate
Effect of increase of rate of money growth
long-run result: equal increase in the inflation rate and the nominal interest rate
fisher effect: one-for-one adjustment of the nominal interest rate to the inflation rate
Shoeleather cost
resources wasted when inflation encourages people to reduce their money holdings
Menu costs
costs of changing prices
Expected real interest rate equation
nominal interest rate - expected inflation rate
Actual real interest rate equation
actual real interest rate = nominal interest rate - actual inflation rate
Fisher effect equation
nominal interest rate = real interest rate + expected inflation rate
Nominal interest rate equation
nominal interest rate = real interest rate + expected inflation rate
After-tax nominal interest rate equation
after-tax nominal interest rate = nominal interest rate x (1- tax rate)
After-tax real interest rate equation
after-tax real interest rate = after-tax nominal interest rate - inflation rate
Price level equation
P = (M x V) / Y
M1 vs M2
M1: currency + demand deposits, savings deposits, traveler’s check, and other checkable deposits
M2: M1 + retail money market mutual fund balances, money market deposit accounts, and small denomination time deposits
