Macroeconomic Theory Section A Flashcards
Primarily, macroeconomists use microeconomic principles to study
long-run economic growth and (short run) business cycles
What are the key characteristics of models/assumptions
Idealised, simplified and informative (but may not always be right)
What are the main macroeconomic variables?
- Output
- Investment
- Employment
What is an endogenous variable (with examples)
Determined within the model, e.g. GDP, inflation, interest rate.
What is an exogenous variable (with examples)
Determined outside the model, e.g. various “shocks”, e.g. productivity shock, monetary shock.
What is a parameter?
the fixed relationship or coefficients which link the endogenous and exogenous variables
What is the difference between flow and stock?
Flow: measured during a period, e.g. investment.
Stock: measured at a point in time, e.g. capital stock
When should we choose a static model?
If the “question” at hand does not involve intertemporal interdependence, i.e. what you do now only affects the present, then we should choose a static model (“method”), e.g. labour market
When should we choose a dynamic model?
If the “question” does involve intertemporal interdependence, i.e. what you do now affects both the present and the future, then we should choose a dynamic model (“method”), e.g. capital market.
If a model is dynamic, what do we need to decide?
If uncertainty matters
What are ad hoc models
- In the old days (1930s-1970s), the mainstream macroeconomists rely on the “ad hoc” models to establish the equation systems, e.g. IS/LM.
- ad hoc” here refers to a modelling methodology, which formulates aggregate relationships in the model based on specific theoretical assumptions or empirical observations.
- That is to say, an ad hoc model is built piece by piece and may not be a coherent system, because different theories are not necessarily compatible.
When should a deterministic model be used?
- If the model is dynamic
- If the “question” at hand focuses on the long run trend (economic growth)
- uncertainty does not matter that much (the “less important”)
When should stochastic models be used?
- If the model is dynamic
- If the “question” focuses on the short run fluctuations (business cycle),
- uncertainty and expectations are essential in modelling the cyclical behaviour
What do households, firms, banks and government aim to maximise?
Household = utility
Firms = Profit
Banks = profits
Government = minimises social welfare losses (or to maximise votes)
What characterises a competitive equilibrium?
Economic agents are price-takers
According to the Lucas critique, the effects of changes in economic policy…
Cannot always be predicted by looking at historical macroeconomic relationships
Which aspect of macroeconomics generates the most controversy?
the causes of business cycles
The real interest rate is
equal to the nominal rate of interest minus the rate of inflation.
What does NIPA stand for?
National Income and Product Accounts
What are the 3 approaches to measuring GDP?
Expenditure approach, Product approach and Income Approach
When a firm produces output…
The firm’s output contributes to GDP only to the extent that there is value-added
What is GDP?
The monetary value of final output produced during a given period of time within a country
What is the product approach?
Sum of value added of all producers
How can you measure GDP using the expenditure approach?
C + I + G + (X – M)
How can you measure GDP using the income approach?
wage + profits + interest + taxes
The income-expenditure identity is best paraphrased as…
All spending generates income
Inventory investment consists of
inventories of finished goods, goods in process, and raw materials.
When there is positive inflation
growth in nominal GDP exceeds growth in real GDP
Real GDP values current production at
base year prices
National saving minus private saving is equal to
the government surplus
A price index can be computed by
dividing a nominal variable by its real counterpart.
GDP and GNP may differ
because some income generated by domestic production may be received as income by foreign residents.
The value of a producer’s output minus the value of all intermediate goods used in the production of that output is called the producer’s
Value added
A business cycle peak is a
relatively large positive deviation from trend in real GDP.
Business cycle persistence refers to the property that
when real GDP is above trend, it tends to stay above trend, and when it is below trend, it tends to stay below trend
A time series is
a sequence of dated measurements.
When a macroeconomic aggregate is procyclical
its deviations from trend are more often of the same sign as the deviations from trend in GDP.
If x is useful for predicting future GDP then
x is a leading variable.
If the correlation between GDP and y is -0.75, we say y is
Countercyclical
If the correlation between GDP and y is 0, we say y is
Acyclical
A lagging variable can be recognized by the fact that
the turning points of GDP happen before its turning points
If deviations from trend in a macroeconomic variable are positively correlated with deviations from trend in real GDP, that variable is said to be
Procyclical
If deviations from trend in a macroeconomic variable are negatively correlated with deviations from trend in real GDP, that variable is said to be
countercyclical
If a macroeconomic variable tends to aid in predicting the future path of real GDP, it is said to be a
Leading variable
If real GDP helps to predict the path of a particular macroeconomic variable, it is said to be a
Lagging variable
Forecasting the future path of real GDP by exploiting past statistical relationships
can be accomplished by the construction and use of an index of leading variables.
Real consumption tends to be
procyclical and less variable than real GDP
Real investment tends to be
procyclical and more variable than real GDP
Employment tends to be
procyclical and less variable than real GDP
Average labour productivity is computed as the
ratio of real GDP to the level of employment
Average labour productivity tends to be
procyclical and less variable than real GDP
One example of a Phillips Curve would be a
positive relationship between deviations from trend in the level of prices and the level of aggregate economic activity
Employment is
less variable than real GDP
Seasonal adjustment tends to
smooth a time series with an important seasonal component
A dynamic decision is one that
involves planning over more than one time period.
A static decision is one that
involves planning over one time period
The utility function captures
how an individual consumer ranks consumption bundles.
A utility function
needs to measure the relative amount of happiness of an individual
What is the equation for the unemployment rate?
Unemployed/Labour force
What is the equation for participation rate?
Labour force/working age population
What is the GDP deflator equation?
100x NGDP/RGDP
A consumption bundle
is a particular combination of consumption and leisure
The property of diminishing marginal rate of substitution follows from the property that the indifference curve is
bowed in toward the origin
What is a barter economy?
An economy without monetary exchange
A numeraire is
A good used as a unit of account
The real wage denotes
the number of units of consumption goods that can be exchanged for one unit of labour time
A consumer’s real disposable income equals
wage income plus profit income minus taxes.
The household budget constraint may have a kink because
leisure is limited by the number of available hours
The substitution effect measures
the responses of quantities to changes in the relative prices of goods
The profit-maximizing quantity of labor equates the marginal product of labor with
the real wage
When the representative firm maximizes profits
the marginal product of labour equals the wage
Labour demand is decreasing in the wage because
Labour demand is decreasing in the wage because
What is the difference between an open and a closed economy?
Closed economy - no interaction with the rest of the world
Open economy - deals with international trade
In the one-period model
government spending is the acquisition of goods, which the government throws away
A competitive equilibrium is a state of affairs in which
economic agents are price takers and markets clear.
In the one-period competitive model we have been studying
consumption is endogenous and total factor productivity is exogenous
The production possibilities frontier represents
all technologically feasible combinations of consumption and leisure
The PPF determines
the set of feasible outcomes
Points on the production possibilities frontier have the property that they
show the maximum amount of leisure that can be consumed for given amounts of goods consumed.
A Pareto optimum is a point that
a social planner would choose
The concept of Pareto optimality is a
useful concept because it defines economic efficiency
Which of the following causes the competitive equilibrium to fail to be Pareto optimal
proportional taxes on wages
An increase in total factor productivity
increases consumption, increases output, and increases the real wage
An increase in total factor productivity shifts the PPF
upward, and also changes its slope
