Macro Unit 4 Flashcards
Why the AD curve slopes downward? Which reason is the most important?
-The Wealth Effect
-The Interest Rate Effect
-The Exchange Rate Effect
The interest rate effect is the most important
Theory of liquidity preference
Theory that the interest rate adjusts to bring money supply and money demand into balance
Nominal interest rate vs. real interest rate
Nominal: interest rate as usually reported
Real: interest rate corrected for inflation
When you increase price level, what happens to money demand and the interest rate?
Money demand increases and the interest rate that bring the money market into equilibrium increases
When interest rates a higher, what happens to investment and the Q of goods and services demanded?
Investment decreases and the quantity of goods and services demanded decreases
Equilibrium interest rate
The quantity where money demand exactly balances the quantity of money spooked,
What happens to AD when the Fed increases money supply?
By increasing money supply, interest rates are lower and the quantity of goods and services demanded increases, moving AD right
What happens to AD when the Fed contracts money supply?
Interest rates rise, reducing the quantity of goods and services demanded, which shifts AD left
Federal funds rates
The interest rate banks charge each other fr short term loans
Monetary policy can be described in terms of…
The money supply or interest rate
Fiscal policy
The government’s choices regarding the overall level of government purchases or taxes
The multiplier effect
The additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending
Ex. If the government gets $20 billion, the AD curve shifts a little larger than 20 billion
What happens to the economy with the multiplier effect?
More money from the government raises employment and profits. Workers earn more and firms get bigger profits, and firm owners are able to raise spending on consumer goods, which raises the demand for goods and services
What happens to AD when the government increases purchases or cuts taxes?
A decrease in government purchases or and increase in taxes shifts AD left
What happens to AD when the government alters spending or taxes?
The shift of AD can either be larger or smaller than the fiscal change
What does the multiplier effect do to AD?
It amplifies the effects of fiscal policy on AD
What does the crowding out effect do to AD?
It tends to dampen the effects of fiscal policy on AD
Disposable income
Income that does not go to necessities (left over money after paying for necessities)
Autonomous consumption
Consumption that does not vary with income (occurs even when income is ZERO) ex. Utilities
Average propensity to consume
The % of income that a consumer spends on average
Consumption (in $)/Income (in $)
Marginal propensity to consume
The likelihood of you spending then next dollar you earn
Change in consumption (in $)/Change in income (in $)
Average propensity to save
100%-% average propensity to save
Marginal propensity to save
1-MPC
Crowding out effect
The reduction in aggregate demand that results when fiscal expansion raises the interest rate
When the government makes a purchase, there is an increase in demand which raises incomes of workers and owners of firms. As income rises, households plan to buy more goods and services and hold most of their wealth in liquid form. The increase in income raises demand for money.
