Flashcards in All Notes Deck (118):
What factors effect demand?
Px=Price of good x
Py=Price of other goods
Y=Income of consumer
N=Population & Demographics
E=Expected future Prices
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
Z=Number of sellers
E=Expected future prices
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)
What factors effect YED?
Level of Income (Less income = greater proportionate change)
Product Perception (Snob goods, Veblen)
The Economic Climate
Who bares the tax incidence?
If the product is elastic, the producer will bare more of the tax
What is the formula for tax incidence?
Consumers can compare bundles of goods and rank them in order of preference
Consumers ranking of goods are consistent, if A>B B>C then A>C
Having an extra unit of a good is at least as beneficial as the last
There are no "sudden jumps" in utility
What is the difference between ordinal & cardinal ranking?
Ordinal: Best to worst
Cardinal: Exactly how much better one thing is
What is the slope of a budget constraint?
What is the point of satiation?
Where the consumer is consuming an infinite amount of the goods
Why is the indifference curve not a straight line?
What is the slope of the indifference curve?
MRSxy= -Change Y/Change X= MUx/MuY
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
Describe the Net effects of an IC and budget constraint movement.
Both positive = Normal Good
Substitution > Income = Inferior good
Substitution < Income = Giffen Good
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
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
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
What are the risk attitudes?
U[E(X)] < E[U(X)]
What are the risk attitudes graphs?
Risk Averse: Concave
Risk Loving: Convex
Risk Neutral: Straight line
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
What is the Markowitz risk premium?
The difference between certainty equivalent and the expected utility of the good
What is the slope of the isoquant?
MRTS = MPL/MPK
If MRTS = 12, for every one unit of labour there must be 12 capital
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 )
What is a firms shutdown condition?
Operating Profit = TR-VC<0
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
Why must a firms long run supply curve lie above the ATC?
If price is lower than this, firm will exit industry
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
What is the Lerner index and how is it calculated?
A measurement of market power:
Larger value = more market power
Name the three oligopoly models
Bertrand, Cournot and Stackleberg
What is the Bertrand model?
Price Competition - EC efficent
Each firm sets price, undercut each other until P=MC
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
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
Why would a kinked demand curve occur?
Limits on Quantity
Describe the varying shapes of an IC?
Positive Slope: One good you like, one you don’t
Negative Slope: Two goods you like/dislike
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
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.
What is a more realistic version of the multiplier?
What is the formula for investment?
What will happen if IR increases?
Investment will fall therefore downwards transaltion of AE
What is Hicks model?
Three markets: Goods, Money and Bonds
If two are in equilbrium the third must be
What is the formula for the demand of money?
If IR go p, people will get bonds thus D falls
How would you increase the money supply?
Open Market Ops:
Print money and purchase bonds
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
How do you calculate the ROR on bonds?
(Maturity - Current Price) / Current Price
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
What are the two types of money supply?
Exogenous = Vertical
Endogenous = Horizontal
Algebraicly, what are the different money supplys?
CU=Currency held in pocket
CRES=Currency held by commercial banks
DEP=Deposits in bank accounts
What is the money multiplier?
M1/M0 = [CU/DEP + 1]/[CU/DEP + CRES/DEP]
What is the LM Curve?
Illustrates here the demand for liquidty = M0
What is the IS equation?
IS=Intercept - Slope
What factors effect the slope of the IS curve?
b=Sensitivity of invesment with regards to IR
tax and MPM
What is the equation for the LM curve?
A bigger h will yield a flatter curve
What effect will expansionary market ops have on ISLM model?
M increases shifting LM1 outwards
What is the effect of expansionary fiscal policy on ISLM model?
IS shifts upwards
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
What is the equation for the economy at equilibrium?
Y= 1/1−c+(bk/h) * (I+G+b/hM)
this is ^ the multiplier
What is monetary retro action?
The extent to which the money supply diminishes due to the multiplier
What is the equation for the monetary multiplier?
∂y/∂M=(p/h) / 1−c+(bk/h)
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
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
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
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
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
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
Why does demand for liquidity have a non linear shape?
As IR falls, the demand for liquidity tends to infinity, you keep all income
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
Discuss the liquidity trap?
When IR has reached its lower bound, monetary policy is no longer effective
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
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
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
What is the term for competetiveness?
R=E x P*/P
E = Exchange rate (P*/P)
P* = foreign price level
Show a depreciation
1$=£0.85 -> $1=£0.89
Here, the pound has devalued
What are the improved formula for X and M
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
What effect does a depreciation have on IS curve?
A depreciation will shift IS curve upwards
A appreciation will shift IS curve downwards
What is the equation for the balance of payments?
x1 Y*+X2R − (M1Y-m2R)=0
X1=MPM for rest of world
M1Y=MPM of our income
What is the uncovered interest parity condition?
Real interest rates will equalise globally
ETe is the future expected rate
k(I−i*)>0 =there will be a finanical inflow
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
How do you represent the CA & KP graphically?
What are the key terms for currency movements?
Devaluation and revaluation are fixed only
Appreciation and depreciation are free float only
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
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
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
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
Where does the equilibrium occur in a fixed ER?
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
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
Where does the equilbrium occur in a free exchange rate?
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
R,Y&I are the three variables that have to be determined
Depending on which exchange rate mechanism, one of the equations becomes redundant
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
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
Derive AD in a flexible ER
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
Derive AD in a fixed ER
Less money available therefore demand falls
IS shifts inwards
IR lower, therefore financial outflows
CB buys £, money supply contracts
Higher price, lower output
What are the shift variables for each exchange rate?
In fixed, shift variable is G
In float, shift variable is M/p
What is the production function for an economy?
As capital and tech are fixed
Y=f(N) - man hours
What are the neoclassical properties of the neoclassical labour market model?
Constant Returns to scale?
Positive but diminishing returns
What is the equation for the demand of labour
Condition for optimal
w/p=fN′=MPN or W=PfN′
More hours will be demanded until wage = MPN
What is the equation for the supply of labour?
Households are the determinant
Combining the above:
s.t. c=w/p^e (12−L)
LF is a point of full employment, a vertical line
The distance between the equilibrium and LF is unemployment
Discuss the effect of bargaining power.
Bargaining power shifts the supply curve upwards
High unemployment diminishes bargaining power
What is the optimal conditon for labour demand
The middle section is PED
What is the formula for Aggregate Supply
P=P^e+λ(Y−Y ̅ )
What factors shift the LRAS & SAS
Improvements in Tech will shift LRAS
Expected prices will shift SRAS
Define and discuss the AD curve under flexible ER
M is Primary Shift Factor
M, I, and We are shift factors
I* = Global interest rate
ε^e=Expected exchange rate
An improvement in all 3 will shift the curve to the right
Define and discuss the AD curve under fixed ER
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
What is monetary Neutrality?
CB increases m - Lower IR
AD shifts outwards
Customers Raise wages
AS shifts upwards to SREquilbrium=LRAS
Y only shifted in SR, LR = inflation
On ISLM, both curves shift outwards then slowly backwards
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
For an equilibrium π=π^e ⁆therefore 0=λ(Y−Y ̅ ) and (Y=Y ̅ ) therefore no output gap
What shifts a SRAS when plotting inflation?
Differences in expected inflation rates
What is the equation for DAD under flexible exchange rates
π=μ−b(Y−Y_(−1) )+h(Δi*+Δε* )
m−m_(−1)=μ is the growth of the money supply
What is the equation for the Philips curve
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
What is the capital accumulation equation
K ̇=sK^a L^(1−a)−dK
What is the steady state?
Where the change in K =0