Midterm I Flashcards
What is the Investment-Savings curve?
The combination of interest rates and GDP that is consistent with a goods market equilibrium.
What is real investment?
Aggregate investment in the economy, the total level of current consumption traded for future consumption
What is an increase in microeconomic investment, but not real investment?
A person buying a bond from another person who uses those funds for consumption
Expenditure is a function of […]
Consumption, Investment, and Govt Spending
Why is investment a decreasing function of real interest rates?
Investment becomes more expensive, so firms demand less of it.
Why is consumption an increasing function of disposable income?
Engel’s Law, people with more disposable income consume more.
Which variable causes the expenditure curve to slope upwards?
E = C + I + G
Consumption, as it is the only one variable to income
Also note the curved slope due to declining MPC.
What are the three reasons people hold money?
For transactions, as precauation, and for speculation
What does the speculative motive imply about money demand?
That it is inversely correlated with the interest rate
Money is an imperfect subsitute for bonds, ergo: M(d) = P x L(r, Y)
What does the transaction motive imply about money demand?
That it depends on prices relative to income.
What does the precautionary motive imply about money demand?
That it depends on the number of expected future transactions
What is money supply represented by a vertical line?
Because it is exogenous and controlled by the government
When the government increases spending, what happens to IS?
The increase in expenditures leads to an increase in output, shifting it outwards
Why does an increase in output (Y) increase money demand (Md)?
The Transaction Motive
What does the crowding out effect mean in the context of IS-LM?
Govt spending raises interest rates, represented by a movement up a shifted IS curve back to the IS-LM equilibrium
Increased M(d) increases r, lowers I and E, and thus lowers Y
What happens when the government increases the money supply?
Intrest rates go down, increasing investment and output
The LM curve shifts outwards
How are the effects of government spending naturally dampened?
The increase in output caused by expenditures will cause an increase in money demand. This will raise interest rates, lowering investment, lowering expenditure, and thus lowering output.
How are the effects of an increase in money supply naturally dampened?
The increase in output caused by the lowering of interest rates will increase money demand. In turn, this raise interest rates and thus lowers output.
What is aggregate demand?
The relationship between the price level and output which is consistent with both the fianacial and goods market equilibirums.
What (intially) happens to IS and AD when the govt increase spending?
Both shift outwords, but price remains constant while interest rates rise
When the central bank increases M(s), what happens?
The LM and AD curves shift out
What is a Type I firm?
One that adjust prices immediately to new information
p(1) = P + a(Y - Ybar)
What is a Type II firm?
One that adjust prices beforehand and cannot change them
p(2) = P^e + a(Y - Ybar)
What is the average price level?
The weighted average of those set by Type I & Type II firms
P = s(1) x p(1) + (1 - s(1)) x p(2)
How does one derive the SRAS?
By taking the formula for the average price level and subtituting the formulas for p(1) and p(2)
What happens when SRAS < LRAS?
A recession
What is true about firms in the long-run?
They are all Type I
When actual output exceeds natural outpute, what is true of prices?
Y > Ybar
Actual prices exceed expected ones
P > P^e
When expected prices exceed actual ones, what is true of output?
P < P^e
Natural output exceeds actual output
Y < Ybar
What is the underlying assumption of adaptive expectations?
Low volatility
What are adaptive expectations?
That expected future prices are equal to current prices
P(t)^e = P(t-1)
What does the theory of adaptive expectation say?
That the expected price will rise or fall to meet the actual price during a demand shock (via SRAS)
Expansionary fiscal policy permenantly raises what?
(While in place)
Prices and Interest Rates
Expansionary fiscal policy temporally raises what?
(While in place)
Output and Inflation
What happens intially in the IS-LM model when the govt pursue a fiscal expansion?
The increase in E shifts the IS curve out, while the increase in P dampens this by shifting the LM curve in by less
What happens to output during a fiscal expansion?
It grows intitially due to IS and then returns to the natural level due to LM
What is the worst kinf of shock?
finanacial ones
What are the three types of shock?
Finanacial crises, consumer shocks, and supply shocks
What is the statistical discrepency?
GDP - GDI, which should be equal
What is NDP/NNP
GDP/GNP minus capital utilization
Why are durables sometimes not included in PCE measures?
Because they can represent investment over the long-run
What are the three subdivisions of PCE?
Durables, non-durables, and services
What does Govt Consumption, Expenditures, and Gross Investment used to measure?
The weight of the public sector
How is Personal Savings calculated?
Personal income minus expenditures and taxes
What are government reciepts?
The income of the government, accross all sources
Incl. taxes, ss contributions, govt entreprises, assets, etc.
How is the Lapreyes index calculated?
By weighting equal to their share in the basket
How is the Paasche index calculated?
By weighting goods according to the oldest data point and using the current year as the base
How is the Fisher-Ideal index calculated?
Using an average of Lapreyes and Paasche
How is the Chain-weighted index calculated?
By applying the Fisher-Ideal index to each consecutive pair of years and taking the average
What is the money market equilibirum?
When M(s) = M(d)
What is the goods market equilibrium?
When Y = E
How can an increase in infaltion expectations cause a recession?
By causing Y(t) to fall below Ybar
SRAS: P(t) = P(t)^e + a(Y - Ybar)
