Macroeconomics Flashcards
What is gross domestic product (GDP)?
The total value of all finished goods (and services) produced within a country’s borders in a given year
How is GDP commonly calculated?
By measuring total expenditures: the sum of private consumption, gov’t spending, investments in capital, and net exports (exports minus imports)
What is another way to calculate GDP?
By measuring income and costs: the sum of wages, interest, rent, profits, depreciation, and indirect business taxes (e.g. sales tax)
What is gross national product (GNP)?
The total value of all finished goods (and services) produced by a country’s resources, whether or not produced within that country’s borders
Thus, it is the same as GDP but adds production done by the country outside its borders and subtracts production done by foreigners within its borders
GNP is not as commonly used as GDP
What is net domestic product (NDP)?
GDP
- depreciation
= NDP
What is national income?
NDP
+ net income earned outside the borders
= national income
What are transfer payments?
Transfers of money without any exchange of goods or services – usually as some sort of gov’t redistribution (e.g. welfare, social security, business subsidies)
What is personal income?
National income \+ transfer payments - corporate income taxes - undistributed corporate profits - social security contributions = personal income
What is disposable income?
Personal income
- personal income taxes
= disposable income
What is real per-capita output?
GDP / population size, and adjusted for inflation
Used to measure the country’s standard of living
What is the difference between cyclical and counter-cyclical (or defensive) businesses?
Cyclical businesses perform better during economic expansions and worse during economic recessions, while counter-cyclical businesses do the opposite
What are the four stages of business cycles?
(1) trough = lowest point
(2) recovery = moving upward
(3) peak = highest point
(4) recession = moving downward
What are economic indicators?
Any trends or evidences that signify at what stage of the business cycle the economy will be (or is, or was) in
What are the three different kinds of indicators?
(1) leading = signify what phase the economy will be entering into
(2) coinciding = signify what phase the economy is currently in
(3) lagging = signify what phase the economy was previously in
What are some examples of leading economic indicators?
(i) avg. hours worked per week by manufacturers
(ii) initial unemployment claims
(iii) stock prices
(iv) bond prices
What are some examples of coincident economic indicators?
(i) industrial production
(ii) unemployment rate
(iii) personal income (minus transfer payments)
What are some examples of lagging economic indicators?
(i) corporate profits
(ii) interest rates
(iii) avg. length of employment
What is the acceleration principle?
The principle that firms invest in response to rising or lowering demand, which tends to amplify that increase or decrease in demand
E.g. if there is an excess of consumer demand, then the firm will seek out further investment (capital) to meet that demand, which itself increases demand for that capital, leading to other firms’ increased investments, and so on – demand increases with acceleration
What are the main tenets of classical economics?
Heavy emphasis on the self-correcting nature of the market
- e.g. in the long run, without intervention, there will be no unemployment, since wages and laborer demand will adjust until reaching equilibrium
- similarly, in the long run shortages and surpluses naturally correct themselves
How do classical and Keynesian economics differ in viewing the equilibrium of an economy?
Classical economics holds that an economy is at equilibrium only if it has full employment, while Keynesianism holds that it can be in equilibrium without full employment
How do classical and Keynesian economics differ in viewing the importance of government spending?
Classical economics holds that gov’t spending tends to hinder economic activity; the free market self-operates when buyers and sellers operate freely according to their self-interest, and gov’t spending disrupts that path towards equilibrium
Keynesianism holds that gov’t spending is integral to an economy alongside consumer spending and business investment, and holds that gov’t spending can sometimes be needed to kickstart economic growth by stimulating demand
How do classical and Keynesian economics differ in viewing fiscal and monetary policies?
Classical economics holds that fiscal policies (set by gov’ts) and monetary policies (set by central banks) tend to hinder the free market, while Keynesianism holds that they can be helpful, sometimes necessary, in stimulating economic growth
How do classical and Keynesian economics differ in viewing wage flexibility?
Classical economics hold that wages are naturally flexible enough to adjust to full employment, while Keynesianism holds that wages can be inflexible in changing that way
What is a production possibilities frontier (PPF)?
A graph showing the quantities of two goods (one for each axis) that can be produced if resources are being used with perfect efficiency, including full employment
Naturally forms a negatively-sloped concave curve, with the line bulging out away from the origin
What is the significance of a PPF?
Since it shows what combinations of goods can be produced at maximum efficiency, it follows that any plotted points inside the curve indicate some amount of inefficiency, whereas plotted points outside the curve are impossible
Moreover, any shift in the curve indicates economic growth or decilne
What are average propensity to consume (APC) and average propensity to save (APS)?
The degrees to which consumers either consume or save their income
APC = consumption / income APS = savings / income
Since all income is either consumed or saved, APC + APS = 1
What are the formulas for marginal propensity to consume (MPC) and marginal propensity to save (MPS)?
MPC = Δ consumption / Δ income
MPS = Δ savings / Δ income
How do interest rates affect consumers’ willingness to save?
Higher interest rates increase savings and decrease consumption
How do taxes affect consumers’ willingness to save?
Income taxes act effectively as decreases in interest rates
Property and estate taxes can also lower incentives to save (since the gov’t is going to take more of it away)
How does debt affect consumers’ willingness to save?
Consumers with a lot of debt are more willing to save than otherwise
How do consumer attitudes affect their willingness to save?
If consumers value long-term wealth and security as desirable, then they will be more willing to save
However, if consumers think they will have a safety net in the future (e.g. social security), then they will be less willing to save
How do durable goods affect consumption and spending?
Since durable goods by definition last for a long period of time, then they can be consumed at a high level while being purchased infrequently (e.g. everyone uses refrigerators but purchases them very rarely)
What are three different components of investment?
(1) residential construction
(2) inventory
(3) plant and equipment
How do interest rates affect willingness to invest?
Lower interest rates increase a willingness to invest, since new projects have a smaller interest cost
What are autonomous investments?
Investments made due to their expected return, regardless of how the national economy is performing
Always a constant value
According to Keynesian economics, when does equilibrium occur in an economy?
When aggregate demand (i.e. personal consumption + gov’t spending + autonomous investment) equals aggregate supply (i.e. total production)
What is the multiplier coefficient?
Because the same income is spent multiple times as money circulates through the economy, increases in private consumption, gov’t spending, or autonomous investments can lead to multiplied increases in national income – which is measured by the multiplier coefficient
How is the multiplier coefficient calculated?
multiplier coefficient = 1 / marginal propensity to save (MPS)
How does the multiplier coefficient show how much a change in spending affects a change in national income?
Δ NI = (1 / MPS) x Δ spending
What is the tax multiplier coefficient?
Measures the degree to which changes in taxes affect the national economy
How is the tax multiplier coefficient calculated?
tax multiplier coefficient = -MPC / MPS
How does the tax multiplier coefficient show a change in net income?
Δ NI = (-MPC/MPS) x Δ taxation
What is a budget surplus or budget deficit?
These emerge when revenues for the gov’t (taxes) differ from expenditures
Surplus = if taxes > expenditures Deficit = if expenditures > taxes
What is the difference between the nominal interest rate and the real interest rate?
The real interest rate is the nominal interest rate adjusted for inflation
The difference between real and nominal interest rate will be an “inflation premium” (increasing the real rate to arrive at the nominal rate) or a “deflation discount” (decreasing the real rate to arrive at the nominal rate)
What determines changes in the interest rate?
The supply of and demand for money itself
Supply can be altered by monetary authorities (a central bank, like the Federal Reserve), whereas demand can be altered through different motives consumers have to acquire money
What is the general characteristic of the monetarist theory of economics?
Emphasizes the steady though controlled growth of money supply as significant for economic activity, rather than fiscal policy (i.e. gov’t spending)
What is the general monetarist criticism of fiscal policies?
Fiscal policies tend to act too late, thus over-correcting the economy when it is already self-correcting, swinging the pendulum too far the other way
What are the general characteristics of the supply-side theory of economics?
Emphasizes tax cuts as incentives to work, save, and invest, thus stimulating economic growth
- particularly opposed to progressive taxation (higher tax rates for higher income)
- holds that tax revenues would not be decreased very much, either, since the lower rates would lead to greater income
- also opposed to wealth redistribution, seeing it as a disincentive too
What are the general characteristics of the neo-Keynesian theory of economics?
Combines Keynesian and monetarist theories
-sees value in fiscal policies, but also emphasizes the control of monetary supply in order to corral inflation
What is money?
Any medium of exchange, whose value derives from the fact that others will accept it
What are different ways the money supply can be measured?
Different types of money will be included – the narrowest measure is M1, though M2 and M3 are broader measures that economists can use to measure money supply
What money is included in M1?
Physical money (coins and cash) and checking accounts
What money is included in M2?
Money in M1 + savings accounts, small time deposits (<$100k), and non-institutional money market funds
What money is included in M3?
Money in M2 + large time deposits (>$100k), short-term repurchase agreements, and institutional money market funds
What is the role of the Federal Reserve (Fed)?
As a central bank, it
- controls the U.S. money supply
- oversees the overall banking system
- acts as the fiscal agent of the U.S. gov’t
- holds deposits for member banks
- facilitates check clearing
What are minimum reserves and federal funds?
Banks are required to have a minimum amount of money on hand
If banks have excess reserves, they can lend money to banks with shortfalls – and these loans are called federal funds, with the interest rate on the loans being the federal funds rate
What is monetary policy?
Policy concerning the money supply, particularly as related to credit, spending, and inflation
What are open market operations (OMO)?
The primary tools in a monetary policy – involves buying and selling gov’t securities on the open market in order to increase (with purchases) or decrease (with sales) the money supply
What is the discount rate?
The interest rate at which member banks can borrow from the Fed
Lowering this increases the money supply by increasing borrowing; raising it does the opposite
What are reserve requirements?
The minimum number of reserves that banks are required to keep on hand – expressed as a percentage of total customer deposits
Higher reserve requirements lead to less money lent out by banks, and thus decrease the money supply – lower reserve requirements do the opposite
Not commonly used to affect monetary policy, since it is so powerful
What are margin requirements?
Investors can purchase only a certain amount of securities on credit; the amount they borrow must not be more than a certain amount they already have in their accounts
The requirements for how much investors must have in their accounts are called margin requirements – and if the Fed changes these, the money supply changes (increase in margin requirements –> decrease in money supply)
There can also be other “credit controls” that apply to non-security transactions
What are different ways in which monetary policy activity can lag?
(1) recognition lag = time to recognize a change in the business cycle to react to
(2) administrative lag = time to execute a policy change
(3) operational lag = time for economy to react to Fed policy changes
These lags can cause monetary policies to actually make problems worse, rather than solve them
What are inflation and deflation?
Inflation = decrease in the purchasing power of money; increase in price levels
Deflation = increase in the purchasing power of money; decrease in price levels
How does inflation affect savings?
It discourages savings, since the money loses real value if it is not earning a return greater than or equal to the inflation rate
How does inflation relate to wealth redistribution?
As money loses value over time, wealth tends to get redistributed arbitrarily – e.g. on a loan, the principal is more valuable to the debtor earlier than what he pays back to the creditor later, so the creditor actually loses wealth in the transaction (independently of interest)
What is the consumer price index (CPI)?
Measures the aggregate price of certain items that are typically purchased, and compares it to a base value to track inflation
What is the wholesale price index (WPI)?
The same as CPI, except it measures the items at wholesale quantities before comparing it to a base value
What is the cost-push theory?
Sees inflation as caused by increased product costs that lead to higher prices for consumers
Labor unions are seen as especially significant in causing this
What is the demand-pull theory?
Sees inflation as caused by excess aggregate demand which then leads to higher prices to meet that demand
-the demand is itself seen to be caused by an expansionary fiscal policy (i.e. where gov’t spending > tax revenue)
When does full employment occur?
When all individuals willing to work at market wages are employed in jobs which utilize their skillset
What is frictional unemployment?
Unemployment that is somewhat inevitable in the economy due to temporary transitions between jobs and/or a lack of full information by workers of available jobs
E.g. a worker eligible for job Y might not know about it when he gets laid off from X, thus leaving him “unemployed” until he learns about Y and gets hired there
What is structural unemployment?
Unemployment that exists not because demand or supply are lacking, but because there is a fundamental mismatch between the two
-e.g. the offered jobs might be too far away, the workers might lack the skills needed, wages offered may be too low
Technology becoming obsolete can cause big mismatches in skills offered and skills demanded
What is cyclical unemployment?
As the business cycle experiences recessions or troughs, the demand for labor will decrease and lead to increased unemployment
What is the relationship between inflation and unemployment?
It has historically been understood as an inverse relationship, though modern economics doubts there is much of a relationship between them
What is the Phillips curve?
A curve made by A.W. Phillips showing a stable, inverse relationship between inflation and unemployment – the general idea is that, as unemployment is low, wages paid for labor increase more rapidly, causing inflation
Modern economics sees this curve as applicable, at most, only in the short run
What is fiscal policy?
The government’s actions and policies done to achieve various economic goals – e.g. unemployment levels, income distribution, national income levels
What is the difference between private and public goods?
Private = consumption can be traced to a particular good; different people can purchase differing quantities of them
Public = benefits are socially distributed (“consumed”), and the goods are not easily divisible or quantifiable; the society (rather than particular individuals) must decide on the allocation of public goods
What are some examples of public goods?
A police force, natural resources, roads, water treatment
What is a drawback of public goods?
They carry inherent inefficiencies in consumption that can sometimes allow others to enjoy the public good without properly paying for it
-e.g. someone who doesn’t pay taxes to a town may enjoy a public basketball court, but ensuring that he would pay for it might be unreasonable or burdensome (such as charging admission, or requiring everyone who uses it to prove residency)
What is the difference between direct and indirect taxes?
Direct = paid by a person directly based on some taxable event (e.g. sales tax, income tax, property tax)
Indirect = some cost or forgone income due to taxation, but which is not paid directly because of some taxable event (e.g. landlords may charge higher rent to cover property taxes they pay on apartment buildings)
What is the difference between progressive, regressive, and proportional taxes?
(1) progressive = taxpayers with more income pay a higher % of their income as tax
(2) regressive = taxpayers with more income pay a lower % of their income as tax
(3) proportional = taxpayers always pay the same proportion of income
Is income tax progressive?
It is formally, but due to the use of deductions, exclusions, and credits, it can end up being less progressive than it first appears
How do property taxes work?
It is a tax on assets (property) rather than income, and since renters pay property taxes indirectly, this tax can also be much less progressive than they seem
How do sales taxes work?
Sales taxes affect taxpayers that spend more of their income, i.e. poorer taxpayers, and are thus regarded as regressive
How do payroll taxes work?
Payroll taxes (e.g. FICA) are regressive since they have a cap on them, above which no taxes are paid – i.e. since higher-income earners tend to pay a smaller portion of income on the tax
What is a value-added tax (VAT)?
A tax paid at each stage of production in manufacturing, where the value that a company adds to a product-in-process is taxed before it is passed on to the next company in the chain – the difference between sales and purchases at each level is taxed
More common in the EU than in the U.S.
What is intergenerational inequity?
When the taxes paid for various benefits occur in a generation later than the one which received the benefits
Can only occur with debt financing, since otherwise the tax revenue has to already be in the government’s pockets for it to be spent
