Midterm 2 Flashcards
What do short run vs long run economics depend on?
Price flexibility:
Prices are fixed in the short run and flexible in the long run
Long run vs short run what do they tell us?
Long run tells us where economy is on average, short run tells us deviations from that average
A country’s standard of living depends on
Its abilities to produce goods and services
Productivity
Quantities of goods and services produced from each unit of labor input (typically measured as labor/hour)
Productivity = Y/L
(Output per worker)
Productivity is a key determinant of
Living standards
What are the determinants of productivity
K, H, N, A, L
K-physical Capital H-human capital N-natural resources A-technology L-labor
Physical capital K and physical capital per worker
Stock of equipment and structures used to produce goods and services
Physical capital per worker: K/L
Human capital H and human capital per worker
Knowledge and skills workers acquire through education, training, and experience
Human capital per worker H/L
Natural resources and natural resources per worker
Inputs into production that nature provides
Natural resources per worker N/L
An increase in N/L causes an increase in Y/L
Technological knowledge (A)
An advance in knowledge boosts productivity and allows society to get more output from it resources
The production function
Y= A F(L,K,H, N)
How does affect the production function
A multiplies the function so improvements in technology allow more output to be produced from any given combination of inputs
What property does the production function have?
Constant returns to scale
What are constant returns to scale
Changing all inputs by the same percentage causes output to change by that percentage
Cobb-Douglas function
Y= AKaL(1-a)
Y is output A is level of technology K is capital stock l is labor a is share of capital
How does saving and investment affect productivity and living standards
Raises future productivity
Invest more current resource in the production of capital K
Requires producing fewer consumption goods
Reducing in consumption means increase in saving
Is fast growth of productivity by increasing K going to be constant
No, because of diminishing returns to capital
As k rises, the extra output from an additional unit of K falls
Catchup effect
If workers have little K, giving them more increases their productivity a lot, but if workers have a lot of K, giving them more increases productivity fairly litte.
The catchup effect: the property whereby poor countries tend to grow more rapidly than rich ones
How does investment from abroad affect productivity and living standard
It is another way for a country to invest in new capital
It increases the economy’s stock of capital
Higher productivity and higher wages
State of the art technologies developed in other countries
Especially good for poor countries that cannot generate enough saving to fund investment projects themselves
Foreign direct investment vs foreign portfolio investment
Foreign direct investment is capital investment that is owned and operated by a foreign entities
Foreign portfolio investment:
Investment financed with foreign money but operated by domestic residents
(Foreigners buying stocks or bonds)
How does education affect productivity and living standards
Education is investment in human capital
Opportunity cost: wages forgone
How do health and nutrition affect productivity
Health care expenditure is a type of investment in human capital (healthier workers are more productive)
Whats is the vicious cycle vs the virtuous cycle
Vicious cycle:
Poor countries are poor because their populations are not healthy, populations aren’t healthy because they are poor
Virtuous cycle:
Policies that lead to more rapid economic growth would naturally improve health outcomes, which in turn would further promote economic growth
How do property rights and political stability affect productivity
One must protect property rights in order to foster economic growth, property rights are a prerequisite for the price system to work
Political instability creates uncertainty over whether property rights will be protected in the future, when people are afraid there might not be property rights or they might be violated: less investmen, including from abroad, and the economy functions less efficiently …. lower living standards
How does free trade affect productivity and growth and living standards
Also: what types of policies are involved with this
Inward oriented policies:
Tariffs, limits on investment from abroad
Aims to raise living standard by avoiding interactions with other countries
Outward oriented policies:
Elimination of restrictions on trade or foreign investment
Promotes integration with the world economy
How do research and development affect productivity
It improves technological process which is the main reason why living standards rise over the long run
Policies that can promote technological process: patent laws, tax incentives for private sector, grants for basic research universities
How does population growth affect productivity
More workers to produce goods and services: larger total output of goods and services
Can affect living standards in three ways:
1) stretching natural resources
2) diluting capital stock (lower k/L)
3) promoting technological process
What trade offs do household face in relation to saving
Households consider trade off betweeen current consumption and saving for future consumption
What trade off do firms face in relation to saving
Forms need to consider trade offs between investment spending today for improvements in future productivity or in production of consumption goods
Gdp in a closed economy
Y= C+I+G
National savings
S
Y-C-G=S
( note this is the same as Y-C-G = I)
S= Y-C-G S = prívate savings + government savings S = (Y-T-C) + (T-G)
In a closed economy: savings (s) =
Investment (I)
T=
Taxes minus transfer payments
An expense for household but an income for the government
Disposable income
Disposable income = Y-T
Prívate savings
Sp= Y-T-C
Income households have left after paying for taxes and consumption
Government savings
Sg= T-G
Tax revenue the government has left after paying for its spending
Budget surplus
T-G > 0
Excess of tax revenue over spending = positive public saving
Budget deficit:
T-G < 0
Shortfall of tax revenue from government spending= negative public saving= G-T
What do household do with saving
Let saving accumulate in saving or checking accounts
Purchase a certificate deposit at the bank
Buy corporate bonds or equities
Buy shares of a mutual fund
What is investment
The purchase of new capital
Does not include the purchase of stocks of bonds
Where does the supply of Liana le funds come from
Saving: private saving and government saving
Where does the demand for loanable funds come from
Investment
Firms borrow the fund they need to pay for new capital
Households borrow the funds they need to purchase new houses
The equilibrium quantity of loanable funds equals..
Equilibrium investment and saving
Where national savings = investment
Types of policies that can affect the market
Saving incentives
Investment incentives
Government budgets deficits or surpluses
Crowding out
Happens when the government borrows to finance its deficit, leaving less funds available for investments
Or
When budget deficits push up interests, which reduce investment demand as well
Fiat money vs commodity money
Fiat money:
Money without intrinsic value used as money because of government decree
Commodity money
Takes the form of a commodity with intrinsic value
Money ( a stock concept)
An asset that is generally accepted as payment for goods and services or repayment of debt
Wealth(astock conept)
Value of assets minus liabilities, these assets are the total collection of pieces of property that serve to store value
Income (a flow concept)
A flow or earnings over time
Functions of money
Medium of exchange
Unit of account
Store of value
What is the federal reserve system (the fed)
The central bank of the United States
An institution that oversees the banking system and regulates the money supply
What is monetary policy
Setting of the money supply by policy makers in the central bank
Money supply equation
M= C+ D
C is currency
D is demand deposits
Or
M= 1/R x initial deposit
Money multiplier
1/R
Reserve ratio
Reserves/deposits
The portion of total deposits that the bank decides to hold onto
100% banking system
A system in which banks hold all the deposits as reserves
Fractional reserve banking:
A system in which banks hold a fraction of their deposits as reserves and loan the rest of it out
Liabilities
Includes deposits and discount loans (from government)
Assets
Include loans, reserves, and other things (such as bonds)
The fed can change the money supply by
Changing the money multiplier
Or changing bank reserves
Open market operations:
The purchase and sale of US government bonds by the fed
Fed buys a government bond from a bank to increase bank reserves and the money supply.
It pays by depositing new reserves in that banks reserve account, and the bank makes more loans, increasing money supply
Fed sells government bond to banks to reduce money supply— removes reserves form the banking system
Fed lending to banks
Fed can influence the amount of reserves banks borrow by adjusting the discount rate (the interest rate on discount loans the fed makes to banks)
Using the reserve requirement to change money supply
The fed can change the reserve requirement ratio to affect the money supply
Reducing the reserve requirement lowers the reserve ratio and increases the money multiplier
Bigger money multiplier = more money supply?
Interest reserves and money supply
The fed can raise interest on reserves kept at the fed to increase the reserve ratio and the money multiplier (the fed pays interests on reserves kept at the fed)
Federal funds rate
The federal funds rate refers to the interest rate that banks charge other banks for lending them money from their reserve balances on an overnight basis
Do fed funds have an impact on bank reserves?
Fed funds transfers simply redistribute bank reserves and enable otherwise idle funds to yield a return, no impact on total bank reserves
How do OMO’s raise the fed fund rate?
The fed sells government bonds, which reduces reserves from the banking system, reducing the supply of federal funds, causing the federal funds rate to rise
What does the federal reserve system include:
Federal reserve banks Board of governors Federal open market committee Federal advisory council 3,000 member commercial banks
Name two regional federal reserve banks
Richmond and Atlanta
What are some policies that may boost growth and living standards and productivity
Offering tax incentives for investment: k/L increases
Offering tax incentive for investment by foreign firms
K/L increases
Give cash payments for good school attendance
H/L
Crack down on government corruption
A increases
Allow free trade
A increases
Give away condoms
L decreases
