Recap of EC107/108

Question 1

What is the equation for the IS curve?

Answer 1

y = A - ar

Question 2

What does A and ar stand for in the IS equation?

Answer 2

A = autonomous consumption 
ar = the -ve impact of r on investment

Question 3

What are the issues with the IS model? What assumptions does it make?

Answer 3

1) Consumption is only shown to be dependent on taxation and not interest rates
2) Investment is only dependent on the interest rate and not levels of income

Question 4

What is the shape of the IS curve and what does this show about the relationship between r and y?

Answer 4

It is downward sloping -> as r decreases output increases

Question 5

What are the properties of the IS curve?

Answer 5

It is downward sloping
A change in the multiplier changes the slope
A change in investment sensitivity to r changes the slope
A change in (A) will shift the curve

Question 6

What does the Dynamic IS curve capture and how is that different to the regular IS curve?

Answer 6

It captures the reality that there is a one period lag between a change and r and the effect that that will have on investment and GDP

Question 7

What is the equation of the Dynamic IS curve?

Answer 7

Yt = A - ar(t-1)

Question 8

What does the Phillips curve capture the relationship between?

Answer 8

Inflation and expected inflation

Question 9

What is the equation for the PC?

Answer 9

inflation = last period’s inflation + A(output gap)

Question 10

What do prices change in accordance to in the PC?

Answer 10

Nominal wages -> as nominal wages increase, prices increase

Question 11

What could cause a change in nominal wages in the PC?

Answer 11

A +ve or -ve output gap

Question 12

What is the shape of the PC in inflation-y space?

Answer 12

It is positively sloping -> when output exceeds equil. output then inflation increases

Question 13

Where do the foundations of the PC lie in?

Answer 13

The labour market

Question 14

What is the relation of inflation to unemployment?

Answer 14

As unemployment increases, inflation will fall

Question 15

What causes the PC to shift?

Answer 15

Changes in the labour market

Question 16

Why do firms set wage above a worker’s reservation wage?

Answer 16

To induce effort

Question 17

How does the level of unemployment impact the cost of job loss?

Answer 17

At high unemployment, the cost of job loss is higher

At low unemployment, the cost of job loss is lower

Question 18

What do firms set wage at in perfectly competitive markets?

Answer 18

They will set wage at the opportunity cost of working (reservation wage)

Question 19

How do output gaps affect the wage and WS curve?

Answer 19

A positive output gap will see employment increase and as such increases pressure on nominal wage
A negative output gap will see employment decrease and will decrease pressure on nominal wages

Question 20

In a closed economy, what are the sources of supply shocks?

Answer 20

Shifts in WS or PS

Question 21

What is the difference between real product wage and real consumption wage?

Answer 21

Real product wage (W/P) is before tax and real consumption wage (W/Pe) is after tax

Question 22

What 2 factors can cause WS to shift?

Answer 22

Efficiency wage factors

Union-related factors

Question 23

What are examples of efficiency wage factors that shift WS?

Answer 23

A fall in unemployment benefits

An improvement in working conditions -> increases the cost of unemployment

Question 24

What are examples of union-related factors that shift WS?

Answer 24

Less legal protection for unions
A reduction in union bargaining power
Unions exercising more bargaining restraint

Question 25

What does the gap between WS and the opportunity cost of working consist of?

Answer 25

1) real wage mark-up required to incentivise worker effort

2) the mark-up coming from worker bargaining power

Question 26

For the PS curve equation:

Answer 26

Check slides

Question 27

PS changes depend on what?

Answer 27

+vely on wage changes

-vely on productivity changes

Question 28

What will cause the PS to be flat?

Answer 28

If there is a constant MPL -> when labour productivity is constant

Question 29

What is the PS negatively marked up under?

Answer 29

Productivity -> PS is equal to productivity minus the mark-up of productivity over the wage set

Question 30

What are examples of price push factors?

Answer 30

1) a fall in the tax wedge
2) a fall in the mark-up e.g. due to tougher competition rules
3) a rise in productivity

Question 31

For maths about price changes and the PS equation?

Answer 31

Check notes

Question 32

What will the CB need to do to make best policy predictions?

Answer 32

Predict the PC so that they know where the economy will be in the next periods

Question 33

What is the CB constrained by?

Answer 33

The PC

Question 34

What does beta stand for in the CB loss function equation?

Answer 34

The level of aversion to inflation

Question 35

What do the CB’s isoquants represent?

Answer 35

The CB’s preferences relating to inflation and output

Question 36

What does the PC show the CB?

Answer 36

The variations of inflation and output attainable for a given inflation expectation

Question 37

Where will the CB’s optimal response be?

Answer 37

Where the PC is at a tangent to the CB isoquants

Question 38

What does the MR show?

Answer 38

The ideal combinations of inflation and output for any PC that the CB may face

Question 39

What does the CB do once they have identified their ideal output gap?

Answer 39

They read of the IS to figure out what r is needed to achieve that output gap

Question 40

What does the CB need to take into consideration when setting r?

Answer 40

That there is a one period lag between the change in r and the effect on GDP

Question 41

What does the CB need to do to overcome the one-period lag from a change in r?

Answer 41

Forecast inflation and output for the next period so that they know what the ideal r will be