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1

What factors effect demand?

Px=Price of good x
Py=Price of other goods
Y=Income of consumer
T=Tastes
N=Population & Demographics
E=Expected future Prices

2

What factors effect supply?

Px=Price of good x
Pa=Price of substitutes in production
• What else could the factory be used for?
Pi=Price of inputs
Te=Technology
Z=Number of sellers
E=Expected future prices

3

What factors effect PED?

Availability of Substitutes (Many Substitutes = Elastic) Time (In the long run price elastic)
Advertising (More = Inelastic)
Type of product (Essential = Inelastic, Luxury = Elastic)
% of Income (Less = Inelastic)
Durability (More = Inelastic)

4

What factors effect YED?

Level of Income (Less income = greater proportionate change)
Product Perception (Snob goods, Veblen)
Lifestyle changes
The Economic Climate

5

Who bares the tax incidence?

If the product is elastic, the producer will bare more of the tax

6

What is the formula for tax incidence?

Producer: |Ed|/Es+|Ed|
Consumer: |Es|/Es+|Ed|

7

Define Completeness

Consumers can compare bundles of goods and rank them in order of preference

8

Define Transitivity

Consumers ranking of goods are consistent, if A>B B>C then A>C

9

Define Monotonicity

Having an extra unit of a good is at least as beneficial as the last

10

Define Continuity

There are no "sudden jumps" in utility

11

What is the difference between ordinal & cardinal ranking?

Ordinal: Best to worst
Cardinal: Exactly how much better one thing is

12

What is the slope of a budget constraint?

-Px/Py

13

What is the point of satiation?

Where the consumer is consuming an infinite amount of the goods

14

Why is the indifference curve not a straight line?

DMU

15

What is the slope of the indifference curve?

MRSxy= -Change Y/Change X= MUx/MuY

16

How do you derive a demand curve from an IC?

Marshallian Demand: Plot the old and new equilibrium
Hicksian Demand: Plot old equilibrium and substitution equilibrium

17

Describe the Net effects of an IC and budget constraint movement.

Both positive = Normal Good
Substitution > Income = Inferior good
Substitution < Income = Giffen Good

18

What is the difference between risk and uncertainty?

Risk: Where possible outcomes and their probabilities are known
Uncertainty: Where we cannot assign probabilities to outcomes

19

How would you calculate expected utility?

Use the Bernoulli function:
U(x)= P1 U(X1 )+P2 U(X2 )…Pn U(Xn)
P1 is the probability of Number 1
U(X1 ) is the utility derived from number 1
U(x) is how many utils consumption provides

20

What is the utility of expected payoff and the expected utility of the payoff?

The utility of the expected payoff: U[E(x)]
The utility obtained by expenditure/income

The expected utility of the payoff:E[U(x)]
The expected utility of the utility of the possible income

21

What are the risk attitudes?

Risk Neutral:
U[E(X])=E[U(X)]

Risk Averse:
U[E(X)]>E[U(X)]

Risk Loving:
U[E(X)] < E[U(X)]

22

What are the risk attitudes graphs?

Risk Averse: Concave
Risk Loving: Convex
Risk Neutral: Straight line

23

What is a certainty equivalent and how is it calculated?

This is the amount of risk free income that we need to receive to get the same amount of utility of risk income.
Calculate expected utility of good, preform the inverse utility function

24

What is the Markowitz risk premium?

The difference between certainty equivalent and the expected utility of the good

25

What is the slope of the isoquant?

MRTS = MPL/MPK
If MRTS = 12, for every one unit of labour there must be 12 capital

26

Illustrate economies of scale using the production function.

Qnew = f (2K, 2L) vs Qbase = f (K, L)
Decreasing returns to scale: less than double output (Qnew < 2Qbase )
Constant returns to scale: double output (Qnew = 2Qbase )
Increasing returns to scale: more than double output (Qnew > 2Qbase )

27

What is a firms shutdown condition?

Operating Profit = TR-VC<0
P-AVC<0

28

How do you derive a firms supply curve?

Firms supply curve is the part of its MC curve that lies above its AVC
If P = MC < AVC the firm will close

The market supply curve is a horizontal summation of all firms supply curves
At each price, add together all outputs that firms are willing to supply at that price

29

Why must a firms long run supply curve lie above the ATC?

If price is lower than this, firm will exit industry

30

Give examples of regulation used against monopolies

Policy intervention to reduce barrier to entry ○ “Antitrust laws”; tax breaks for new entrants
MC pricing rule Require firm to charge P = MC.
Direct price regulation: ATC pricing rule

31

What is the Lerner index and how is it calculated?

A measurement of market power:
(P-MC)/P=-1/Ed
Larger value = more market power

32

Name the three oligopoly models

Bertrand, Cournot and Stackleberg

33

What is the Bertrand model?

Price Competition - EC efficent
Each firm sets price, undercut each other until P=MC

34

What is the Cournot Model?

Quantity Competition - Not EC efficient, better than monopoly
Both firms set Quantity, reaction curves are created.
Efficient equilibrium occurs at intersection of reaction curves

35

What is the Stackleberg Model?

Quantity Competition - More efficient than Cournot
Each firm sets quantity, Qa is set before Qb therefore A works backwards and maximises own gain

36

Why would a kinked demand curve occur?

Limits on Quantity
Non-linear pricing
Discounts
Varying Income

37

Describe the varying shapes of an IC?

Positive Slope: One good you like, one you don’t
Negative Slope: Two goods you like/dislike

38

How would you calculate output max and cost min?

For Output Max:
Hold isocost fixed and shift isoquant
For Cost Min:
Hold isoquant fixed and shift isocost

39

What is Grim Trigger and Tit for Tat

Grim trigger: If you ever Defect, I Defect in all subsequent periods
Tit-for-tat: If you Defect this period, I Defect next period. If you Cooperate this round, I Cooperate next round.

40

What is a more realistic version of the multiplier?

1/ (1-c(1-t)+m)

41

What is the formula for investment?

I=Ibar-bi

42

What will happen if IR increases?

Investment will fall therefore downwards transaltion of AE

43

What is Hicks model?

Three markets: Goods, Money and Bonds
If two are in equilbrium the third must be

44

What is the formula for the demand of money?

Ld=kY-ih
If IR go p, people will get bonds thus D falls

45

How would you increase the money supply?

Open Market Ops:
Print money and purchase bonds

46

Illustrate the effect of Open Market Ops on Bonds.

Bank prints money to purchase bonds
This raises their price, causing the ROR to fall
This causes IR to fall

47

How do you calculate the ROR on bonds?

(Maturity - Current Price) / Current Price

48

What are the different IR?

iD=RoR on a savings account
iB=RoR on a bond
iL=Bank lending rate
iCB=Central bank lending rate

49

What are the two types of money supply?

Exogenous = Vertical
Endogenous = Horizontal

50

Algebraicly, what are the different money supplys?

M0=CU+CRES
CU=Currency held in pocket
CRES=Currency held by commercial banks
M1=CU+DEP
DEP=Deposits in bank accounts
M2=M1+DEP*
DEP*=Special Deposits

51

What is the money multiplier?

M1/M0 = [CU/DEP + 1]/[CU/DEP + CRES/DEP]

52

What is the LM Curve?

Illustrates here the demand for liquidty = M0

53

What is the IS equation?

i=(I+G)/b −(1−c)Y/b
IS=Intercept - Slope

54

What factors effect the slope of the IS curve?

b=Sensitivity of invesment with regards to IR
c=MPC
tax and MPM

55

What is the equation for the LM curve?

i=k/hY −M/ℎ
LM=Slope-intercept
A bigger h will yield a flatter curve

56

What effect will expansionary market ops have on ISLM model?

M increases shifting LM1 outwards

57

What is the effect of expansionary fiscal policy on ISLM model?

IS shifts upwards

58

What is the effect of expansionary fiscal policy on ISLM & Keynesian cross>

IS shifts upwards
Higher income increases money demand therfore CB raises IR
Higher IR therefore AE shifts upwards
Investment is depressed, AE shifts to a point between A and B
Private sector may be crowded out

59

What is the equation for the economy at equilibrium?

Y= 1/1−c+(bk/h) * (I+G+b/hM)
this is ^ the multiplier

60

What is monetary retro action?

The extent to which the money supply diminishes due to the multiplier

61

What is the equation for the monetary multiplier?

∂y/∂M=(p/h) / 1−c+(bk/h)

62

What are the key points of Reaganomics?

Increase in defence expenditure therefore IS right
Reduce taxes therefore IS right / Slope changes
Contraction Market Opps to quell inflation therefore LM left

63

What effect would maintaining the money supply have on a goods market shock?

Shock causes IS to shift
Constant money supply increases/decreases output with a change in interest rates
This method is the best

64

What effect would maintaining the IR have on a goods market shock?

IS shifts, expansionary/contractionary opps causes the buying/selling of bonds which shifts LM Right/left returning market to original position with higher/lower output

65

What factors shift the LM Curve?

A reduction in demand for money will shift LM to right
Increase in demand for money will shift to left

A reduction in supply will shift LM to left
A increase in supply will shift LM right

66

What effect would fixing the money supply have on a money market shock?

Curve will shift due to change in demand and remain at that level

67

What effect would fixing the IR have on a money supply shock?

Countering the increase in money supply through contractionary market ops will shift LM back to original position

68

Why does demand for liquidity have a non linear shape?

As IR falls, the demand for liquidity tends to infinity, you keep all income

69

What is a critical rate and how does it effect the demand for liquidity?

A critical rate of a bond determines the rate at which it is sold. Above this, the demand for liquidity is zero and all funds are invested
Below this, the demand for liquidity is infinite and none are invested
Smoothing this relationship gives the curve
At a flat point of the curve, you have a liquidity trap where monetary policy is ineffective

70

Discuss the liquidity trap?

When IR has reached its lower bound, monetary policy is no longer effective

71

At which points on the Non-Linear LM curves are policies ineffective?

At the vertical section, expansionary fiscal policy is ineffective as an IS curve only raises IR
Here, monetary policy will shift the LM curve, improving output

At the horizontal position, expansionary monetary policy will shift the LM curve, causing no change due to zero lower bound
Here, fiscal policy will shift IS curve, improving output

72

Discuss the effects of a run on the banks.

A run on the bank will increase the demand for money, shifting LM left
A collapse of confidence will raise the risk premium, shifting LM upwards - now in liquidity trap
Only option is fiscal policy

73

Discuss negative IR

Commercial inter bank lending rates can be negative
Bank IR can be negative however if too negative people will not store money in banks

74

What is the term for competetiveness?

R=E x P*/P
E = Exchange rate (P*/P)
P* = foreign price level

75

Show a depreciation

1$=£0.85 -> $1=£0.89
Here, the pound has devalued

76

What are the improved formula for X and M

X=x1Y*+x2R
M=m1Y*-m2R

77

What is the IS equilibrium using the improved X, M equations?

i=−(1−c+m_1)/b x Y + (I ̅+I ̅+x_1 Y∗)/b + ((x2+m2)R)/b
I=Slope + Intercept + exchange

78

What effect does a depreciation have on IS curve?

A depreciation will shift IS curve upwards
A appreciation will shift IS curve downwards

79

What is the equation for the balance of payments?

BP=CA+KP
x1 Y*+X2R − (M1Y-m2R)=0
X1=MPM for rest of world
X2R=Competitiveness
M1Y=MPM of our income

80

What is the uncovered interest parity condition?

Real interest rates will equalise globally
i=i*+(ETe−Et)/E
ETe is the future expected rate
k(I−i*)>0 =there will be a finanical inflow

81

What is the Balance of Payments Equation including the UIP?

BP=x1 Y*+x2R−(m1Y − m2R) + k(i−i*)=0
Solving for I
i=i*+(m1Y)/k − (x1Y*)/k − (m2+x2)R)/k

82

How do you represent the CA & KP graphically?

CA=Verticle
KP=Horizontal

83

What are the key terms for currency movements?

Devaluation and revaluation are fixed only
Appreciation and depreciation are free float only

84

What effect will increasing government spending have on a fixed ER?

G shifts IS to right
Higher IR cause financial inflows causing D£ up
This shifts LM to right until return to FE line
Effective policy

85

What effect would monetary policy have on fixed exchange rates?

LM shifts outwards
Lower IR cause financial outflows S£ up
CB buy back £, returning M

86

What effect would an increase in G have on flexible exchange rates?

IS shift right
Higher IR causes D£ up
£ apprecites, depressing exports
IS shifts back to original

87

What effect would monetary policy have on flexible exchange rates?

Increased money supply therefore LM shifts outwards
IR falls causing a fiscal outflow
£S up therefore depreciation
Demand for exports increase
IS shifts right back to FE line
Effective policy

88

Where does the equilibrium occur in a fixed ER?

FE=IS

89

What effect would raising IR have in a fixed ER

IR up therefore FE up
FE=IS is new equilbrium
Higher IR D£ up
CB buys foreign currencies
LM shifts left

90

Why would you commit to a fixed ER?

Rely on imports, avoid depreciation - will run out of foreign reserves
Rely on exports, avoid appreciation - can print infinite domestic reseves

91

Where does the equilbrium occur in a free exchange rate?

FE=LM

92

What are the IS, LM & FE Equations?

IS: (EP*)/P = R = (1−c+m1)/(m2+x2 )Y − (I ̅+G ̅+x1 Y*)/(m2+x2 ) + b/(m2+x2)i
LM: Y=m/k + hi/k
FE: i=i*
R,Y&I are the three variables that have to be determined
Depending on which exchange rate mechanism, one of the equations becomes redundant

93

What does a flexible ISLMFE equibrium look like?

Y=m/k + hi*/k
Sub (Y) and (i,i*) into equation IS for real exchange rate
Most important variable is M

94

What does a fixed ISLMFE equibrium look like?

(EP*)/P = R = (1−c+m1)/(m2+x2 )Y − (I ̅+G ̅+x1 Y*)/(m2+x2 ) + b/(m2+x2)i*
Sub into LM to work out Y
Most important variables are I, G, x1Y

95

Derive AD in a flexible ER

Prices rise
Real money supply falls therefore LM shifts left
Endogenous appreciation occurs
IS1 Shifts right due to reduced demand
Price has risen and output has fallen

96

Derive AD in a fixed ER

Prices increase
Less money available therefore demand falls
IS shifts inwards
IR lower, therefore financial outflows
CB buys £, money supply contracts
LM inwards
Higher price, lower output

97

What are the shift variables for each exchange rate?

In fixed, shift variable is G
In float, shift variable is M/p

98

What is the production function for an economy?

Y=f(A,K,N)
As capital and tech are fixed
Y=f(N) - man hours

99

What are the neoclassical properties of the neoclassical labour market model?

INADA
Constant Returns to scale?
Positive but diminishing returns

100

What is the equation for the demand of labour

π=P∗Y
π=P∗f(N)−W∗N
∂π/∂N=P∗fN′−W=0
Condition for optimal
w/p=fN′=MPN or W=PfN′
More hours will be demanded until wage = MPN

101

What is the equation for the supply of labour?

Households are the determinant
U=U(c,L) s.t
W∗N=P∗C
12=L+N
Combining the above:

U=U(c,L)
s.t. c=w/p^e (12−L)

102

Discuss LF

LF is a point of full employment, a vertical line
The distance between the equilibrium and LF is unemployment

103

Discuss the effect of bargaining power.

Bargaining power shifts the supply curve upwards
High unemployment diminishes bargaining power

104

What is the optimal conditon for labour demand

Optimal Condition:
w/p=(1+dP/dy∗y/p[y] )∗f_N^′
The middle section is PED

105

What is the formula for Aggregate Supply

P=P^e+λ(Y−Y ̅ )

106

What factors shift the LRAS & SAS

Improvements in Tech will shift LRAS
Expected prices will shift SRAS

107

Define and discuss the AD curve under flexible ER

P=a−bY+h(M,i*,ε^e )
Logging
p=m−bY+h(i*,ε^∗ )
M is Primary Shift Factor
M, I, and We are shift factors
M=Money supply
I* = Global interest rate
ε^e=Expected exchange rate
An improvement in all 3 will shift the curve to the right

108

Define and discuss the AD curve under fixed ER

P=a−bY+(E,P*,Y*,I*,ε* )
Logging
p=e+p*−by+δY* δG−f(I*,ε^e )
G is main shift factor
P* is foreign prices
Y* is foreign output (+)
I* is foreign interest rates
ϵ^∗ is expected ER
Apart from foreign interest Rates and Expected ER, an increase will cause a rightwards shift

109

What is monetary Neutrality?

Flexible ER
CB increases m - Lower IR
AD shifts outwards
Customers Raise wages
AS shifts upwards to SREquilbrium=LRAS
Repeats
Y only shifted in SR, LR = inflation
On ISLM, both curves shift outwards then slowly backwards

110

What is the equation for SRAS when plotting inflation?

p=p^e+λ(Y−Y ̅ )
Subtract previous price levels
p−p_(−1)=p^e−P_(−1)^e+λ(Y−Y ̅ )
This can be combined to yield
π=π^e+λ(Y−Y ̅ ) SRAS

111

Derive EAS?

For an equilibrium π=π^e ⁆therefore 0=λ(Y−Y ̅ ) and (Y=Y ̅ ) therefore no output gap

112

What shifts a SRAS when plotting inflation?

Differences in expected inflation rates

113

What is the equation for DAD under flexible exchange rates

p=m−bY+h(i*+ε*)
p_(−1)=m_(−1)−bY_(−1)+h(i_(−1)*+ε_(−1)* )
p−p_(−1)=m−m_(−1)
π=μ−b(Y−Y_(−1) )+h(Δi*+Δε* )
m−m_(−1)=μ is the growth of the money supply

114

What is the equation for the Philips curve

π=π^e−g(μ−μ_N )
π^e=π_(−1)

115

Discuss Solows neoclassical exogenous growth model

Y=K^a L^(1−a )
First Derivate is positive
Second is negative
More output at a diminishing rate
Constant returns to scale - PC

116

What is the capital accumulation equation

K ̇=sK^a L^(1−a)−dK

117

What is the steady state?

Where the change in K =0
k*=(s/(d+n))^(1/(1−a))

118

What is the requirement line?

The amount of investment required to maintain a constant level of GDP
If rate of savings increases, steady state rises
If population growth increases, requirement pivots left and steady state falls