Term One Flashcards
What are the differences between GDP Deflator and CPI
CPI:
Fixed basket of goods
Goods from domestic and imports
GDP Deflator:
Basket of Goods varies
Only Domestically produced G and S
What is the difference between GDP and GNP,
Give a NFP defintions
GDP is all domestically produced G and S regardless of producer nationality.
GNP is GDP Plus Net Factor Payments (NFP)
It is all G and S produced by economies nationals, regardless of where it was produced.
NFP: payments to domestic factors abroad minus payments to foregin factors in domestic.
Is GDP a Stock or Flow Variable
It is a Flow,
Wealth is an example of a stock variable.
Why would you use chain-weighted GDP.
Give an explanation.
When you use constants base year for real GDP, prices can change significantly (e.g Computers) and the base year is no longer representative.
Chain -Weighted uses moving base year for the prices to ensure that the prices keep up to date with technological advancements.
Derive Saving Accounting Identity using GDP and the Saving from personal disposable income.
PDI= Y-T
Saving = PDI - C
Y= C + I + G + X - Z
S= I + G + X - Z - T
S + (T-G) = (X-Z) + I
Private + Gov Saving = NX + Investment = Total Saving
Define the Nominal Exchange Rate
It is the The price of a unit of domestic currency in terms of foreign currency. Dollars per each pound.
Donated by letter S
Define the Real Exchange Rate
It is the ratio of prices between domestic and foreign goods when they are expressed in the same currency.
Donated by sigma
Sigma = SP/P*
Define the effect of absolute purchasing power parity
where in the long run prices of domestic and foreign goods become equalized, therefore the real exchange rate is equal to 1.
Define relative purchasing power parity
In the long run, the real exchange rate is constant.
What is the Ballassa- Samuelson effect
In richer countries, non-tradeable goods have a higher price because they have higher demand.
What happens to tradeable prices
they equalise
What are the internal terms of trade
Where P is the price of non-traded goods and P* is the price of traded goods.
What are the external terms of trade
P are goods that exported
P* are goods that are imported
What happens to net exports when the real exchange rate depreciates?
domestic goods will cost less the foreign goods.
Therefore import demand falls as they are more expensive (relatively).
Domestic firms will try to offset this by producing there own substitutes for cheaper.
This will result in an increase in the level of export demand.
What is the difference between static and dynamic models?
Static Models are in a steady state and tell you what the equilibrium is. They are a snapshot at one point in time.
Dynamic models show you the equilbrium and how to move away and towards it. They are across time periods.
What is Okun’s law? Give the equation.
if output is above trend rate, then unemployment will be below equilibrium and visa-versa. U -Ubar= -g(Y-Ybar)
Define the output gap
The percentage difference between the actual output and the trend output.
What is a leading, lagging or coincident varible.
Leading and lagging are obvious.
Coincident means that they move at the same time.
What are the three types of arbitrage?
Triangular, Spatial and Yield
Explain Yield Arbitrage
There is an inverse relationship between price and rate of return for a bond.
Yield is where the process of buying and selling causes the rate of return of two bonds to become equalised.
What is spatial arbitrage?
It is where the rate of return of bonds differs due to their geographical location.
What is an arbitrage opportunity?
It is where someone makes a profit due to a difference in the price between two investment opportunities.
What is triangular arbitrage?
Where there are three countries and you convert from one currency to the other.
Then when you complete the full circle, you should have the initial investment left over. If not, it is because of arbitrage differences.
Write down the UIP condition
It=I*t-(St+1-St)/St
Is the UIP a static or Dynamic model?
Dynamic, it incorporates time.
What does a star next to a variable mean in the UIP model
It means that it is an ‘abroad’ variable.
What happens to the exchange rate if the domestic interest rate increases?
It will appreciate. Ceterus Paribus!!!!
What variables are endogenous in The UIP model?
Nominal Exchange Rate
Domestic Prices
Domestic Interest Rate
What variables are exogenous in the UIP model?
Output
Money Supply
World Prices
World Interest
Define the real exchange rate
The real exchange rate is defined as the ratio of the prices between two countries when they are given in the same currency.
What are the short-run assumptions for the overshooting model
Prices are fixed (sticky)
Nominal exchange rate will change freely and rapidly.
What are the long - run assumptions for the overshooting model?
Purchasing power parity holds, in absolute terms. Therefore the real exchange rate is equal to 1.
Nominal exchange rate is stable, St+1=St and It=It+1
What does the MM curve show and what does it entail?
It shows NER and Price level and the interaction between the UIP condition and the Real Money stock in the economy.
What is St+1 and St
t+1 is the long run NER
T is the short run NER
Why is the MM curve upward sloping?
St and Pt go up together
Explain in the short-run what happens if the exchange rate or prices are overvalued?
Demand shifts away from domestic goods.
Prices fall and NER falls to keep the money market in equilibrium.
Explain what happens if prices are undervalued?
Abroad demand for domestic goods increases.
The price increases and so does the NER to keep it in equilibrium.
What does the Overshooting model actually show? Who published the model and when?
Rudi Dornbusch published the model in 1976.
The model shows that due to a number of changing factors, the volatility of exchange rates is higher in the short-run than the long-run because the model overshoots the equilibrium.
Imagine an increase in the Money Supply, draw a diagram to show the UIP overshooting models
Look at your notes where it moves from A to B to C.
What is shown by the Keynesian Cross model?
Explain what happens when DD>Y and DD
Y=C(Y-t)+I(r)+G
DD>Y: The demand is greater than output. There is decumulation of inventories by firms and the output increases.
DD
Explain the features of Consumption, investment and government spending
C=Co+C1(Y-T)
Co is autonomous C1 is the marginal propensity to consume.
Y-T is disposible income.
Investment is a negative function of real interest which is given by the fischer equation.
Government spending is exogenous.
Outline the Intuition behind the multiplier effect. From a government spending increase.
- The gov spending increases by change in G
- Demand (DD) increases by change in G.
- Firms increase output by change in G to prevent decumulating inventories.
- Income will rise by change in G.
- MPC x change in G is the consumption increase.
- Consumption increase will cause demand and income to increase again.
- This second increase will cause consumption to increase by MPC x (MPC x change in income).
What does it mean to be;
- To the right of the IS curve.
- To the left of the IS curve.
Right: Supply of goods is greater than demand.
Left: Demand for goods is greater than supply.
What do different DD’s represent when deriving the IS curve?
What does a higher DD show?
How would you derive the IS curve?
They show different levels of interest.
Higher DD shows a lower level of interest. because of more investment durrrr.
IS curve is derived by find the corresponding levels of Y for each interest on the DD.
What happens to the IS curve from an increase in Government Spending.
It will shift out because DD shifts upwards but interest is constant. So straight parallel shift from A to B.
What does it mean to be;
The right side of LM Curve
The left side of LM Cuvre
- right side shows the demand for real balances is greater than supply.
- left side shows the demand for real balances is less than supply.
Draw the LM derivation and highlight the effect of being on the right and left side.
Lecture 5 macro, slide 43 for answers.
What effect on LM does an increase in the money supply have?
It causes the LM curve to shift out. lecture 5 macro, slide 47 for more ANS
What is the real exchange rate
It is the relative price of domestic goods in terms of foreign goods.
What does the primary current account function depend upon?
Income (-)
Equilibrium income (-)
Real exchange rate (-)
What does the financial integration line show?
it shows where the capital market of the world are in equilibrium.
As domestic/ foreign rates are not equal, capital flows towards the one with higher rate of return, until they are equalized.
What is the Mundell-Flemming Summary.
Can you draw diagrams for each of the scenarios?
Fixed: Floating:
Fiscal- increase none
Monetary -none increase
foreign interest - Decrease increase
What is the Mundell-Flemming summary for exogenous/endogenous instruments?
Exogenous Monetary: fixed = Exchnage rate, floating = Money supply
Endogenous Monetary: fixed = Money supply, floating = exchange rate
What are the three states of working age people?
Employed
unemployed
Retired
What does a household indifference curve for labour supply show?
What is shown by a shift in the curve?
Consumption power (hours worked)
Leisure
(hours not worked)
A curve shift shows a change in economic welfare.
What is the formula for the household budget line
(Lbar - L) x W = C
C= actual earnings
What is the slope of household budget constraint?
it is - W
Draw a diagram to show the effect of a wage increase on a household.
Lecture 7 slide 15
Assuming consumption and leisure are both normal. What effect will a wage rise have?
It will cause both to increase. However, the substitution effect will be greater than the income effect so consumption will increase the most.
What are the axis labels for a labour supply curve?
Real wage (Y)
Labour Supply (X)
How to derive labour demand?
Lecture 7, Slide 24.
On the production function diagram, you put the wage line (w1 ) tangent to production function, i.e; MPL1 =W1.
Then trace down to bottom diagram and trace across w1.
Repeat for more wages, giving the demand curve when you join up the dots.
Why is the slope of the demand for labour curve negative?
Because of diminishing returns to MPL.
What would shift the labour demand curve?
A change in the productivity of workers or accumulation of capital.
What does the labour demand curve show?
The labour demand curve actually shows the marginal product of labour for each labour quantity and real wage combination.
What is the result of an increase in labour productivity?
The labour demand curve shifts outwards and the production function for labour shifts upwards.
What is the formula for MPL?
it is (partial F / partial AL ) x A
What does weird L bar represent?
Maximum amount of labour possible.
Therefore:
Lbar - L is voluntary unemployment.
What are the axis for the labour market equilibrium diagram?
Real wage (Y)
Labour Hours (X)
What could cause an increase in;
- Labour Demand.
- Labour Supply.
- Demand:
Increases in A or K
- Supply:
New entries to labour market through immigration.
How to show involuntary unemployment?
you draw the wage above market clearing level diagram from A Level.
What are the different types of trade unionists?
Hard-Line = Very flat indifference curves, which show that they will give up many peoples jobs in aid of a pay rise.
Job-First: Their focus is employment and will accept a large pay cut for a small employment increase. Very upright indifference curve.
Average: Mixture of the two, mid way between the two indifference curve.
How would you draw Collective labour supply curve?
Do the indifference curves from the train union. The labour demand tangent to each one. Then trace the labour supply curve through the tangency points. This will give the collective supply
L7, S 41.
Unions decide the wage, firms decide the employment (through their demand).
Show labour market equilibrium with Trade Union Present.
Do household labour supply and collective labour supply (collective labour supply gradient is slightly flater)
Do HLS wage as equilib,
Do CLS wage and show involuntary unemployment as
L’-L’’.
What will happen if a union cares more about wage and less about employment?
Through an increase in unemployment benefits.
Their indifference curve will become flatter- they will give up more employment for a small wage rise.
This means that the demand curves will meet the indifference curves further to the left.
This will result in the collective Labour supply curve shifting upwards.
If you draw this effect on a labour market equilibrium diagram, the effect shown will be an increase in involuntary unemployment.
What happens if unions care more about employment and less about wage?
Their indifferecne curves are steeper - the give up less employment for a wage rise.
The labour demand curves are tangent at a lower point in the diagram.
This means that the collective Labour supply curve shifts down.
The result is; lower levels of involuntary unemployment.
What type of wages do unions and firms bargain over?
nominal wages,
with respect to their expectations of inflation.
What happens if inflation is higher than expected?
It means that they were bargaining for lower real wages than they actually expected.
This means collective labour supply is actually lower than they expected, causing employment to increase and involuntary unemployment to decrease.
What happens if inflation is lower than expected?
It will cause real wage to be higher than they expected.
As a result, the collective labour supply curve will be higher and the involuntary unemployment will be higher.
What is the natural rate of unemployment?
U bar:
it is the level of unemployment when the inflation expectations are correct.
What is the expectations augmented Phillips Curve?
U-Ubar = -alpha(Pie-pieE)
Rearrange the expectations augmented Phillips Curve in terms of core inflation.
(pie - piebar) = -b (U - Ubar)
What are the axis for a phillips curve?
Y-axis: inflation
X-axis: unemployment
What is Okun’s law
It is the relationship between the unemployment gap of individuals and the output gap of the economy.
It can be drawn with unempoyment on the x axis and output on the Y axis.
U-Ubar = -g (Y-Ybar)
How do you find the agg supply curve function?
It is the product of the augmented expectations phillips curve and Okun’s law formula.
As the U-Ubar cancels out the aggregate supply function is given by;
(pie - piebar) = bg (Y-Ybar)
What are the axis on the aggregate supply diagram?
Y axis = inflation
X axis = output
What happens to the Phillips curve and aggregate supply curves in the long run?
they are fixed at natural rate of unemployment and equilibrium output, respectively.
This means that they both result in a purely inflationary effect.
What happens to core and actual inflation in the short-run?
In the short run; core inflation can change but actual inflation cannot change.
What happens to core and actual inflation in the long-run?
Core inflation will ‘catch up’ with actual inflation, meaning the two become equal.
it will do this by a shift in the position of the Short-run AS curve.
under fixed exchange rates, what exchange rate is said to be fixed?
The nominal exchange rate is the rate that is fixed.
How to derive the AD under fixed exchange rate?
The nominal exchange rate is fixed S. LM is fixed by money supply. Find IS points for different inflation levels and trace down to give AD.
how to derive AD under floating exchange rate?
LM and IS trace down for equilibrium inflation.
If Inflation increases M/P falls and LM shifts back.
Real/Nominal exchange rate will appreciate, this means the PCA will fall and IS shifts back.
Trace down again and meet new inflation level. This will give AD curve.
What does the LRAD show
IT is the money growth line.
What occurs in the long run in the AS AD model?
Long run inflation is equal to money growth. This gives long run AS under flexible exchange rates.
What determines the gradient of short run AS and AD?
It is the time of the short run, the longer it is defined for, the closer it is to the long-run counterpart.
What happens when AS and AD are under fixed exchange?
The real exchnage rate is unchanging.
Inflation is only sustainable along the trend rate of output Y-Ybar.
What happens when AS and AD are under floating exchange rates?
The monetary authority will choose the rate of growth of money supply.
They hence choose the long run inflation rate (inflation targeting).
Nominal exchange rate will vary to ensure that PPP will hold.
What is stagflation?
It is where both unemployment and inflation increase at the same time.
What happens if there is a negative AS supply shock?
We fight the increase unemployment at point B using expansionary AD. However this causes increased inflation in the long run.
We could also fight the inflation but there is increased unemployment through a deflationary AD programme which will persist until we return to the A equilibrium.
Diagram lecture 9b slide 33.
What happens if there is an adverse demand shock AD?
We will just use either expansionary fiscal or monetary policy to shift AD back up.
What is disinflation?
it is where you reduce the level of inflation, but it is still positive.
Deflation on the other hand is negative inflation, i.e; falling prices.
How to achieve Disinflation.
Draw a diagram to explain further
contractionary demand side policy.
This will cause unemployment pain to begin with.
However; the initial pain will subside when the AS shifts down. Core inflation catches up.
Unemployment reduces and the level of inflation in the economy is lower.
How to get C or I to stay when you change g and T
Change the money supply.
Private saving what is it?
Y-T-C does not have to equal I
What values do you use for the overshooting model?
New M New St+1
Old P because they are sticky.
Why does monetary policy have no effect on AD in fixed exchange rates?
Because it is used to keep domestic and foreign interest rates equal through the UIP condition
What is the natural rate of output.
It is output in the long -run when world = normal inflation.
What will happen if short-run pie is greater than long run?
There will be deteriation in the current account.
