Macroeconomics First Term Flashcards
Who translated the IS-LM and AS-AD models from Keynes?
Higgs
What are the two issues of the IS-LM graph that need to be fixed?
An incommensurability issue as IS is in flow terms and LM is in stock terms
IS uses real interest rate whilst the LM depends on the nominal interest rate - Higgs uses a mix of both
Why are the IS and LM curves based off of different interest rates?
Investment is dependent on future interest rate (IS), whilst decisions to keep cash or put cash into bonds is based on current situation (LM)
What is the Fisher relationship?
1 + i = (1+i)/(1+πe) - multiply this by a planned investment to find returns
Leads to r = i - πe
πe previously seen as constant but in reality this is not the case
What does an upward LM curve mean in terms of money supply?
Money supply is exogenous (straight vertical line on i-L graph)
What is the real life case of the CB setting the money supply?
CB sets a certain interest rate and lets MS adjust - leads to horizontal flat LM, but this is not perfect either
Why does the CB keep the interest rate set?
Shocks in the money market (LM) from commercial banks are mitigated by keeping i the same - predominant thinking since the 1980s
How does the CB choose a certain interest rate?
An inflation target is set by banks and the interest rate is adjusted to reach this, following the Taylor Rule
How was the Taylor Rule found?
Taylor looked at past Fed action and approximated future actions related to interest rate - i is chosen relative t the natural or stabilising rate of i
What is the Taylor Rule equation?
(r-re) = 0.5(y-ye) + 0.5(π-πT) = (rt-rs)
re is the stabilising rate
y-ye is the output gap
πT is 2% for EU
How is r-re found?
Three equations - IS curve, AS and MR
What conditions are the IS held under?
Closed economy as well as flexible exchange rates
As Y = C + I + G, what is C?
C = Co + C1(1-t)y*
Co is based on consumer confidence and is positively correlated with i
C1 has a negative reaction to i as there will be less investment when i is low, so more consumption
What is y in the Minsky model?
y = A - ar where A is consumer confidence and is very volatile
How is y modelled graphically for Minsky?
yt = A - ar^s which is a vertical line on the i-Y graph - the IS is downward sloping and crosses the yt line at i*
What is the output gap in the Minsky model?
(Y-Ye) = -ar - r^s
What are the assumptions surrounding the labour market in this model?
Imperfect competition as it more realistic, with same upward and leftward results as last year
What does equilibrium in the money market cause?
Leads to equilibrium output and therefore equilibrium employment, including involuntary unemployment
What are the changes to the wage setting curve in the Minsky model?
Line No is added to the graph, a right-angle that is either side of the asymptotes of WS and to the left of LF, and represents the perfectly competitive labour supply
What does the WS curve show in the model regarding wages?
The higher the employment rate, the higher the wages as less choice for those that demand labour, from Marx. Distance between WS and perfectly competitive labour supply shows how wages are a function of the voluntary employment rate
How do unions revise wage demands?
W = P* x B(N, Zw), where B is a generic function, N is a positive factor and Zw are shift factors
What effects do shift factors have on wages?
Higher unemployment benefits will lead to higher No and WS so wages will be higher (insurance benefit schemes are similar)
Higher concentration of unions will lead to less intra-competition and the unions will be stronger, WS and No moves upwards (as will be the effect of any positive shift in Zw)
How is the WS curve drawn in the model?
WS is a straight line rather than a curve, linearized
What is the function for firm’s labour demands?
P x dQ/dL = W
The marginal cost of employing one more person