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econ 102 > IS-MP > Flashcards

IS-MP Flashcards

1
Q

what is aggregate expenditure?

A

the total amount of goods and services that people want to buy across the whole economy

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2
Q

what is the formula for aggregate expenditure?

A

AE = C + I + G + NX

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3
Q

what are the four components of AE?

A

Consumption: when households buy goods and services

Planned Investment: when businesses purchase new capital, excluding unplanned changes in inventories

Gov. Purchases: when gov. buys goods and services

Net Exports: spending by foreigners on Canadian made exports, less spending by Canadians on foreign-made imports

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4
Q

what is macroeconomic equilibrium?

A

occurs when the quantity of output that buyers collectively want to purchase is equal to the quantity of output that suppliers collectively produce

Y = AE

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5
Q

what happens to inventories when output is greater than expenditure?

A

inventories increase

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6
Q

what happens to inventories when output is less than expenditure?

A

inventories decrease

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7
Q

what determines output in the short run?

A

demand conditions

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8
Q

what determines output in the long run?

A

supply

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9
Q

what happens when actual GDP > potential GDP?

A

the economy will overheat as it exceeds the economy’s max. sustainable output

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10
Q

what is potential output?

A

the level of GDP at which all resources are fully employed. it is determined by the available supply of labour, human and physical capital, and technological progress

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11
Q

what is actual output?

A

the actual level of GDP

this may fail to meet the potential as AE ebbs and flows

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12
Q

what is the output gap?

A

the difference between actual and potential output, measured as a percentage of potential output

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13
Q

what is the formula for output gap?

A

( actual - potential ) / potential * 100

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14
Q

when is there a + gap?

A

when actual > potential

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15
Q

when is there a - gap?

A

when actual < potential

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16
Q

what is equilibrium GDP?

A

describes the level of GDP at the point of macroeconomic equilibrium

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17
Q

what is potential GDP?

A

the economy’s highest sustainable level of production and is determined by available inputs

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18
Q

what is real interest rate?

A
  • may be the most important price in the economy
  • represents the opportunity cost of spending
  • is the price that determines this year’s AE
  • is a lever policy makers use to influence the economy
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19
Q

what do low interest rates boost?

A

low interest rates increase consumption, investment, government purchases, net exports.

therefore, low interest rates increase aggregate expenditure, and therefore increase GDP, and ultimately increase the output gap

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20
Q

what is the IS curve?

A

illustrates how lower real interest rates raise spending and hence GDP, leading to a more positive output gap

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21
Q

what is on either axis of the IS curve?

A

vertical axis - real interest rate
horizontal axis - output gap

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22
Q

what type of slope is the IS curve?

A

downward sloping

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23
Q

how do changing interest rates affect the IS curve?

A

leads to a movement along the IS curve

as interest rate decreases, moves right along the curve

as interest rate increases, moves left along the curve

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24
Q

what is monetary policy?

A

the process of setting interest rates in an effort to influence economic conditions

25
Q

what is risk-free interest rate?

A

the interest rate on a loan that involves no risk

the federal reserve sets the nominal interest rate to influence the real interest rate

26
Q

what is risk premium?

A

the extra interest that lenders charge to account for the risk of loaning money

27
Q

what is risk premium?

A

the extra interest that lenders charge to account for the risk of loaning money

28
Q

what is the formula for real interest rate?

A

real interest rate = risk-free interest rate + risk premium

real interest rate = nominal interest rate - inflation rate + risk premium

29
Q

what is the MP curve?

A

illustrates the current real interest rate, which is shaped by monetary policy and the risk premium

30
Q

who sets the interest rate?

A

the central bank/ federal reserve

31
Q

how can you determine macroeconomic eqm from a IS-MP graph?

A

the point where IS curve and MP curve intersect

32
Q

what is a recession in terms of AE?

A

declining expenditure

33
Q

what is a expansion in terms of AE?

A

increasing expenditure

34
Q

what is an optimistic IS curve?

A

strong aggregate expenditure leads to a booming economy and full employment

describes spending plans in good times when people are optimistic about their economic future

35
Q

what is a pessimistic IS curve?

A

insufficient demand can lead to an economic slump and unemployment

people are pessimistic about their future, so they cut back on how much they plan to spend at any given interest rate, and businesses will respond by cutting production. this decrease in output shifts the IS curve to the left

36
Q

what shifts the MP curve?

A

monetary policy shifts the MP curve

the shift in the MP curve leads to a new eqm

37
Q

what is recessionary eqm?

A

GDP is less than potential GDP

38
Q

what happens to the MP curve when real interest rate decreases?

A

the MP curve shifts down

39
Q

what happens to federal fund rate when real interest rate increases?

A

increase in federal funds rate

40
Q

what happens to federal fund rate when real interest rate decreases?

A

decrease in federal funds rate

41
Q

what is fiscal policy?

A

the gov. use of spending and tax policies to attempt to stabilize the economy

42
Q

what happens to the IS curve when fiscal policy is adjusted?

A

expansionary fiscal policy = increasing AE = IS curve shifts right

43
Q

what is the multiplier?

A

a measure of how much GDP changes as a result of both the direct and indirect effects flowing from each extra dollar of spending

44
Q

what is the formula for multiplier?

A

delta GDP = delta spending * multiplier

45
Q

how does increased government spending affect the IS curve?

A

the IS curve shifts right

it has a multiplied effect, and so shifts by DG * multiplier

this leads the economy to shift to a new equilibrium

this new equilibrium involves higher GDP, and an unchanged interest rate

46
Q

which policy shifts the MP curve?

A

monetary policy

47
Q

which policy shifts the IS curve?

A

fiscal policy

48
Q

what determines how far the IS curve shifts?

A

the multiplier

49
Q

what is a spending shock?

A

any change in AE at a given real interest rate and level of income

spending shocks shift the IS curve

50
Q

what are the types of spending shocks?

A
  1. consumption
  2. investment
  3. government
  4. net exports
51
Q

describe consumption as a spending shock

A

consumption increases if people feel more prosperous

causes include:
- increases in wealth
- increases in consumer confidence
- increases in government assistance
- reductions in taxes
- reductions in inequality

52
Q

describe investment as a spending shock

A

investment increases if it is profitable to expand production

causes include:
- an expanding economy
- increases in business confidence
- increases in investment tax credits
- reductions in corporate taxes
- easier lending standards and increased cash reserves
- reduced uncertainty

53
Q

describe government as a spending shock

A

government shocks increase in response to fiscal policy

causes include:
- spending bills
- automatic stabilizers

but not transfer payments

54
Q

what is an automatic stabilizer?

A

automatically increasing spending when economy is weak

55
Q

describe net exports as a spending shock

A

net exports increase in response to global factors

causes include:
- increases in global GDP growth
- reduced value of the US dollar
- reduced trade barrier in foreign markets
- increased trade barrier in US markets

56
Q

what is a financial shock?

A

any changes in borrowing conditions that change the real interest rate at which people can borrow

financial shocks shift the MP curve

57
Q

what are the types of financial shocks?

A
  1. monetary policy
  2. risk
58
Q

describe monetary policy as a financial shock

A

changes in monetary policy can raise interest rates by increasing
- the risk free rate
- expected future interest rates

59
Q

describe risk as a financial shock

A

a higher risk premium will raise interest rates due to increased
- default risk
- liquidity risk
- interest rate risk
- risk aversion

econ 102 (10 decks)

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