MACROECONOMIC VARIABLES AND MODELS Flashcards
when there is a change in GPL what three effects occur
- wealth effect
- interest rate effect
- international sub effect
explain the wealth effect
the wealth of households is determined by both financial and physical assets. when there is a decrease in GPL, assuming the HHs nominal wealth stays constant, then the real value of their assets increases. This means they have more purchasing power to consume goods and services. Hence C increases causing a rise in real gdp
explain the interest rate effect
when the average price of everything decreases, households and firms require less money to conduct their daily activities. this means that they are able to save more money, increasing the supply of loanable funds in the loanable funds market. as a result, there will be a downward pressure on ir. fall in ir makes it cheaper for HHs and firms to borrow money to consume and invest since cost of borrowing is lower. Thus, C and I rise
what are the factors that affect C
- expectations about future income levels
- expectation of changes in HHs wealth
- expectation of future change in GPL
- interest rates
- personal income tax
explain how expectations of future income levels affects C
Optimism abt future state of the economy leads to high consumer confidence. a expanding economy often means more job opportunities and higher income so when HHS expect economy to do well, they expect their Y levels to increase in the future. hence, they are more willing to purchase big ticket items like cars and properties.
explain how expectation of changes in HHs real wealth affects C
if HHs expect a rise in real value of wealth due to a property boom or stock market boom driving up prices. they are likely to increase their consumption as the real value of their wealth has increased as they feel wealthier and will demand more goods and services
explain how future changes in gpl affects C
if HHs expect inflation rate to rise, they bring forward their consumption to avoid paying higher prices in the future.
what are the factors that affect I
- ir
- expected ROR of investment
how does ir affect I
interest is the cost of investments for firms. when firms finance their investments, they tither borrow money and pay interest to their creditors or use their undistributed profits and forgo the interest that could have been gained if it were saved in the bank. Hence, profit-motivated firms will only invest if the marginal benefit (ROR) = or exceeds the marginal costs (ir). with interest rates decreasing, previously unprofitable investments become profitable as ROR>ir so these firms will carry out these units of investment increasing I
how does the expected ROR of investment affect I
when firms expect an expanding economy and improving profits, they seek to increase their capacity in order to produce more units of output through the purchase of capital.
what affects G
government policy in response to state of the economy - fiscal policies
what affects X-M
- foreign income levels
- price of foreign goods relative to domestic prices
- exchange rate
explain the multiplier effect
Assuming the economy was initially operating at spare capacity, there will be an increase in AD from AD0 to AD1 due to an increase in C, I, G, X-M causing AD to exceed current levels of output. As firms draw on their inventories to meet the extra demand, there will be an unplanned fall in inventories. Thus, firms will increase their production to meet planned levels on inventories by hiring more FOPS such as labour to increase production and NY increases as a result. As income increases, HHs will spend part of their increased income on consumption of domestic goods and services meaning that induced consumption increases, creating another round of unplanned fall in inventories and the process repeats itself with each round of increase in induced C being smaller than the previous due to withdrawals in savings, taxes and imports. This process ctns until initial increase in AD is fully withdrawn from the circle causing NY to reach a new eqm. NY will increase mtp to intial increase in AD.
what is the size of multiplier given by
1/MPW or 1/(1-MPC)
what is MPW given by
MPS + MPT + MPM
what is MPS affected by
countrys attitude towards thrift - americans have a strong attitude towards conuming while asian counterparts regard savings as a virtue
- social security system — no strong social safety net so they are compelled to save more
- govt policy — compulsory savings through the CPF contribution
what is MPT affected by
tax system of a country
what is MPM affected by
a countrys factor endowment - sg low factor endowment so she has to omport most goods and raw materials
what is the impact of increase in AD when economy near full exployment
an AD shock causes AD to increase from AD1 to AD2. creating shortages,,, firms respond by increasing prodcution and hiring more FOPs like labour. however since ec near full employment then firms are forced to use resources less suitable for production. Thus, increasingly larger amts of labour and output are required per additional unit of output produced. this causes UCOP to increase so firms will only produce extra output if the goods can be sold at higher prices. eqm is restored soley by adjustment in GPL resulting in DD-pull infaltion
what is the impact of AS shocks on an economy
for exp, rise in oil prices leads to a rise in UCOP and a fall in AS as shown by an unpward shift of the horizontal portion of AS from AS0 to AS1. This fall in AS leads to shortages in the economy, putting an upward pressure on price as firms are less willing to produce at the prevailing price level. Hence, GPL increases from P0 to P1 and through the sub effect, wealth effect and int rate effect, national output falls.
