Macro Flashcards
1
Q
What are the 5 macro-economic goals?
A
- Price stability 2. Reducing unemployment 3. Adequate rate of economic growth 4. Reduction in income inequality 5. External equilibrium or balance
2
Q
What does price stability mean?
A
Lowering inflation and coming out of deflation.
3
Q
Why is deflation bad?
A
It decreases demand of inelastic goods and profits go down so there is less investment
4
Q
Example of a country that faced deflation?
A
Japan
5
Q
Why would you not want a fast rate of economic growth? Why adequate?
A
It leads to inflation as more demand is placed on resources.
6
Q
What does external equilibrium or balance mean?
A
- Refers to balance between imports and exports 2. Not always dependent on the country, but deals with trade relations between them 3. Rich can borrow more easily 4. More exports than imports
7
Q
What economic goals might clash with each other?
A
- Economic growth might trigger inflation, which is not price stability 2. Reduction in income inequality can affect growth. 3. Price stability might not be conducive to economic growth.
8
Q
What are the two approaches to macro?
A
Neo classical and neo keynsian
9
Q
What does the neo classical approach deal with?
A
• Supply side • Non-activists • Focuses on the long run
10
Q
Who created neo classical approach?
A
Adam Smith
11
Q
What does the neo keynsian approach deal with?
A
• Demand side • Activists • Focuses on the Short Run
12
Q
In the case of a deflationary gap, what would neo classicists suggest?
A
Self correcting mechanism will bring the economy back to equilibrium because of the wage price flexibility. Therefore people will work for less, so production gets cheaper, so short run aggregate supply increases. The economy will always go back to equilibrium in the long run. We come out of the gap at a lower price level. Graph: SRAS moving down and to the right.
13
Q
What is wage price flexibility?
A
It states that demand of labor is elastic.
14
Q
In the case of a deflationary gap, what would neo keynsians suggest?
A
Self correcting mechanism will not work because wage price flexibility does not work, as there is a lack of wage price stickiness. Also people’s expectations.
15
Q
What is wage price stickiness?
A
When the nominal wage (not adjusted for inflation) is hesitant to change
16
Q
Why is there a lack of wage price stickiness?
A
• Unions and minimum wages mean even if people are willing to be paid less they can’t be • Government intervention (subsidies, e.g. farmers) • Oligopoly is the predominant structure, which makes wage prices sticky
17
Q
How would neo keynsians suggest fixing the deflationary wage gap? How would you come out of the deflationary gap? Graph?
A
Increasing government spending or decreasing taxes. We would come out of the gap at a higher price level. Aggregate demand would move up to the right.
18
Q
What is a deflationary gap?
A
Deflationary gap is the shortfall in aggregate demand from the level required to maintain full employment equilibrium in an economy.
19
Q
What is inflationary gap?
A
IDK An inflationary gap is the difference between the current level aggregate demand and the anticipated aggregate demand that would be experienced when an economy is at full employment, also referred to as the potential GDP.
20
Q
What would a neo classicists approach to an inflationary gap be? Graph?
A
The economy will go back to equilibrium because of increase in costs. Graph: SRAS moves up to the left
21
Q
What would a neo keynsian approach to an inflationary gap be? Graph?
A
Same process as fixing a deflationary gap but shifting D to the left instead, so increasing taxes or reducing government spending. Graph: AD shifts down to the left
22
Q
What is aggregate demand?
A
The sum of all goods and services in all the markets in the economy.
23
Q
How do you calculate aggregate demand? What is this?
A
Equal to spending by consumers, businesses, governments and net exports (exports minus imports). It is just GDP!
24
Q
Why does aggregate demand slope downwards?
A
The income effect and the substitution effect
25
What is the income effect?
If money income remains the same and and the price level decreases, aggregate demand will increase and visa versa.
26
What is aggregate supply?
All the final goods and services which businesses plan to produce at different price levels.
27
What is short run aggregate supply? What's on the axes of the curve?
It assumes that factor prices do not change. Axes: real income vs price level
28
What is the Keynsian SRAS curve? What are the three parts to a Keynsian SRAS curve? What's on the axes of the curve?
It is Keynes theory of the SRAS following a recession 1. Recession - flat 2. Normal 3. Physical limit of production - steep Axes: real income vs price level
29
What is the recession part of the Keynsian SRAS curve?
As production increases the price level changes very little because there are a lot of unused factors available. Once they are put into use, income increased but price level does not because the cost of production does not increase since you are using unused resources.
30
What is the normal part of the Keynsian SRAS curve?
As you produce more you use up more resources so price level increases as producers must be incentivised to make more.
31
What is the physical limit of production part of the SRAS curve?
Output reaches the Neoclassical Long Run Aggregate Supply Curve. There are no more goods to utilise, you cant increase output. It is perfectly inelastic because in the long run nothing is fixed so they can adjust to anything. If the PL decreases they produce more and their income remains the same.
32
What is LRAS?
It assumes that factor prices adjust and shows the relationship between full employment, real income and price level.
33
Why does price level increase as you use up more resources?
Because resources become more scarce and people bid up the price for them.
34
What does the Keynsisan SRAS curve look like?
Curving upwards, starts flat. Eventually turns into LRAS curve which is perfectly inelastic, so it is a straight line down.
35
What is the long run?
A period when all markets are in equilibrium
36
What are the factors that shift AD?
1. Fiscal policy 2. Monetary Policy 3. Foreign Income Changes 4. Expectations 5. External shocks
37
Fiscal policy is:
Government spending and taxation. Actions by the government to stabilise the economy.
38
Monetary policy is:
The use of money supplies and interest rates by the central bank to influence the economy.
39
How can fiscal policy shift AD?
If the government increases spending and/or decreases taxes AD will shift to the right. If they decrease spending AD will shift to the left.
40
Why will AD shift to the right if government increases spending?
AD = C + G + I + (X - m) G is government spending, so increased government spending equals increased AD
41
Why will AD shift to the right if government decreases taxes?
AD = C + G + I + (X - m) Decreased tax means more disposable income so C (consumer spending) goes up
42
How will monetary policy shift AD?
If interest rates are raised then AD will shift to the left. If they are lowered then AD will shift to the right.
43
Why will higher interest rates shift AD to the left?
Higher interest rates mean less borrowing and more saving so there is less consumer expenditure.
44
How will foreign income changes shift AD?
If foreign income increases then AD shifts right.
45
How will currency devaluation shift AD?
AD will shift to the right
46
Why will AD shift to the right if currency devalues?
Foreigners have more money in relation to your goods so there are more exports. Increased exports means higher AD because AD = C + G + I + (X - m)
47
Why will AD shift to the right if currency value increase?
Foreigners have less money in relation to your goods so there are less exports.
48
How do external shocks effect AD?
1. National and international events uncertainty, AD shifts downwards since people save more and there is less investment. 2. Social issues: Negative social environment will lower AD and vice versa. 3. Natural events: Disasters will lower aggregate demand and good events will raise it.
49
What is the multiplier effect?
An initial change in spending will set off a spending chain that is magnified in the economy so the multiplies shows how spending is magnified.
50
Real income is?
The purchasing power of your income adjusted for inflation
51
How do you calculate real income?
Nominal income divided by the price level (?)
52
What is Keynes concept of the multiplier?
He states that any autonomous (independent, invisible hand) change in the economy impacts the economy by more than the amount of the change. E.g. an investment of 10 million will add more than 10 million to the real income.
53
What is marginal propensity to consume?
The amount by which any change in income leads to a change in consumption (on a national scale).
54
How do you calculate mpc?
= ∆C/∆Y change in cost over change in income
55
What is marginal propensity to save?
The amount by which any change in income ;eads tp a change in saving.
56
How do you calculate mps?
=∆S/∆Y
57
mpc + mps =
1
58
why does mpc + mps = 1?
Because you can either consume or save
59
How is the multiplier (K) determined?
By the marginal propensity to consume. The bigger it is, the more money will be multiplied.
60
K =
K = 1/1-mpc = 1/mps
61
Why is the multiplier determined as it is?
Because of the ripple effect. More money means more consumption which means more money for others. If investment/money decreases, impact will be multiplied by k.
62
According to Keynes, how do you get the economy out of a recession?
The government must spend money because nobody else will because they have negative expectations.
63
How do expectations shift AD?
If expectations are positive, AD is shifted to the right.
64
Why do positive expectations shift AD to the right?
People spend more when they are positive about the future of the economy.
65
What is the accelerator?
It explains that the level of planned investment varies with changes in the rate of growth of demand which depends on the rate of growth of income or output.
66
How does the accelerator work?
The rate of income growth will change the rate of the growth of demand which will determine investment.
67
What are the differences between the multiplier and the accelerator?
1. Cause Multiplier is autonomous and caused by investment. Accelerator is income led. 2. Comes from Multiplier comes from a change in autonomous expenditure and accelerator comes from the rate of change in Y
68
What are limitations of fiscal policy?
1. Lags 2. Pork Barreling 3. Irreversibility 4. Crowding out
69
What kinds of lags are there?
1. Recognition lag 2. Political lag 3. Implementation 4. Effectiveness
70
What is the recognition lag?
Time that it takes the government to recognize which phase of the business cycle the economy finds itself in.
71
What is the political lag?
The time that it takes the politicians to reach an agreement, for example passing a bill.
72
What is the implementation lag?
The time it takes the policy to be implemented.
73
What is the effectiveness lag?
The time it takes for an implemented policy to come into effect
74
What is pork barreling?
Politicians do favours for each other and spend a lot hoping to get reelected. This is an inefficient and wasteful.
75
What is irreversibility?
It is impossible or wasteful to stop half way in a project so it may require a large amount of money.
76
What is crowding out? Graph?
1. Direct: government enters the market for a good and crowds out the private sector. 2. Indirect: Government borrows money to start businesses so demand for money increases so interest rates increase which crowds out people who need a loan. Graph: demand shifts to right, with the arrow being government borowing
77
What is the permanent income hypothesis?
Fiscal policy may not be effective in changing consumption habits if the tax changes are not permanent, if tax cut is temporary then money is saved for emergencies and in case taxes are implemented again.
78
What is the life cycle hypothesis?
Studies showed that consumption tends to be relatively stable over time and depends on the part of the life cycle at which we are at/
79
At what stage of life is mpc high?
According to Franco Modigliani, mpc is relatively high in the young adult stage and tends to decrease towards the middle stages and then increases towards retirement.
80
Why is mpc high when you are a teenager and old?
When you are a teenager you dont think because its not your money. When you are old you think you deserve to treat yourself because you have worked hard your whole life. when you are an adult you dont spend as much because you relate every thing to the amount of hours of work it is worth.
81
What factors can shift SRAS?
1. Change in factor prices 2. Change in weather conditions
82
What factors can shift SRAS and LRAS?
1. Changes in quantity of capital (including technology) 2. Changes in quantity and quality of labour 3. Changes in supply side policies affecting incentives 4. Changes in legislation such as age for leaving school and for retirement
83
How does changes in supply side policies affecting incentives shift the SRAS and LRAS?
Countries that allow people to keep more money encourage more entrepreneurship and therefore more supply.
84
How does changes in legislation such as age for leaving school and for retirement shift SRAS and LRAS?
Lowering age for leaving school would provide more labour.
85
What is money?
1. A widely accepted medium of exchange (goods and services) 2. Stores value (investment) 3. Unit of account (it is a measuring tool for value) 4. It is a standard of deferred payment (serves for borrowing and lending)
86
Types of money:
1. Flat money 2. Bank money
87
What is flat money? What are the types of flat money?
All forms of legal tender (medium of exchange) 1. Paper money 2. Commodity money
88
What is paper money?
Usually worth more than the paper it's printed on
89
What is commodity money?
(metallic money such as coins) metallic content may be worth more than the denomination
90
What does counterfeit money do in an economy?
Counterfeit money is known as "bad money" by Sir Thomas Gresham who says "bad money drives out good money" meaning good money becomes worth less, leading to inflation.
91
What is bank money?
• Credit cards (substitutes for money) • Debit cards • Checks • Transfer funds etc.
92
What are the types of interest?
Real and nominal
93
What is nominal interest?
Numerical (e.g. 1.2%)
94
What is real interest?
Numerical adjusted for price changes (e.g. 1.2% interests and 1% inflation = 0.2%)
95
What is the relationship between interest rates and bond prices?
There is an inverse relationship between interest rate and bond prices. As interest rates go up bond prices go down.
96
Why is there an inverse relationship between interest rates and bond prices?
When interest increases, money is put into the banks so demand of bonds decreases. When interest rate increases then the government increases interest on new bonds so old ones are sold. Supply of bonds increases so the price of bonds decreases.
97
What is the fisher equation for exchange?
MV = PQ M = money supply V = velocity of circulation of money P = price level Q = quantity of goods and services produced in the economy
98
In the fisher equation for exchange, what does M stand for?
Money supply
99
In the fisher equation for exchange, what does V stand for?
Velocity of circulation of money
100
In the fisher equation for exchange, what does P stand for?
Price level
101
In the fisher equation for exchange, what does the Q stand for?
Quantity of goods and services produced in the economy
102
In the fisher equation for exchange, what is the problem with PQ?
It assumes that all goods and services produced in the economy are bought
103
What is MV equal to?
Total GDP on expenditure side, which is equal to aggregate demand
104
How is MV equal to the total GDP on the expenditure side?
In theory this should just be money supply, but there are some assets within the set of money supply that remain unspent such as real estates since it is relatively rare they get bought and sold and they do not serve as income for others: they are not liquid. Therefore, you need to multiply money by the velocity of circulation to see the actual aggregate demand.
105
What is price level?
The current weighted average of the price of all the goods and services in an economy.
106
Why is price level weighted?
If a country produces a lot of one cheap good, and a little of an expensive good, if it is not weighted the price level will be far too high. It is weighted because it depends how much a country produces of one good.
107
What does price level indicate about a country?
It indicates essentially how expensive it is to live there. E.g. Norway has a very high price level, Guatemala has a much lower one.
108
How is PQ the GDP from the demand side?
Assuming all goods and services produced are bought, the price level is an average price of all goods and services produced so this would equal the amount of money provided by consumers to suppliers.
109
What does the fisher equation for exchange state?
In the short run, velocity of circulation of money is constant and quantity of goods bought and sold is fixed. Since MV = PQ, any change in money supply will change price level in the same direction and proportion.
110
What are limitations to the fisher equation for exchange and who came up with them?
Milton Friedman said that the velocity of money is not necessarily constant (during an inflationary period or a recession for example) and quantity of goods bought and sold could be increased in the short run if there are unused resources. Fishers equation for exchange assumes that the economy is on the PPF line but in real life no economy works on the PPF line. If not you can increase quantity of goods bought and sold without a proportional decrease in price level.
111
What is the conclusion to Milton Friedman's limitations to the fisher equation for exchange?
Changes in the money supply lead to changes in price level in the same direction but not the same proportion.
112
What does the supply of money depend on?
The definition of money.
113
How many definitions of money are there?
3: M1, M2 and M3
114
What is M1?
The narrowest definition of money. Including currency, chequable deposits and traveller's cheques
115
What is liquidity?
The ease at which an asset can be converted into cash without much loss of value.
116
What is M2?
M1 + savings deposits and less easily transferrable forms of money
117
What is M3?
M2 + large time deposits and less liquid forms of money but NOT stocks and bonds
118
What changes from M1 to M2 to M3?
The forms of money get progressively abstract and less liquid
119
What does M3 not include?
stocks and bonds and even less liquid things
120
What is demand of money?
According to keynes it is the liquidity preference which is most acceptable.
121
Why would you want forms of money that is more liquid?
1. Precaution 2. Transactions 3. Speculations
122
Why does precaution cause you to want money that is more liquid?
In case of emergencies such as inflation or run on the banks, it is better to have easily exchangeable money
123
Why does "transactions" cause you to want money that is more liquid?
Real estate for example holds value, but is not useful because it cannot carry out transactions, where as liquid money can.
124
Why does speculation cause you to want money that is more liquid?
if you speculate that your currency will increase in value, you want more of it
125
What is the opportunity cost of holding money?
The interest rate
126
What factors will shift the demand (or liquidity preference) for money according to keynes?
1. Expectation (of inflation) 2. Higher price level now 3. Changes in real income
127
How will expectation (of inflation) shift the demand for money?
If inflation is expected to go up there will be more expenditure today shifting liquidity preference to the right and vice versa.
128
How will higher price level now shift the demand for money?
It will shift liquidity preference to the right since more money is needed to buy the same goods and services.
129
How will changes in real income shift the demand for money?
More income means more expenditure which will shift LP to the right. If you have more money, you want to spend more money although proportionally you spend less.
130
What factors will shift the demand for money according to Friedman?
1. Total wealth 2. Preferences 3. Cost of holding money
131
How will total wealth shift the demand for money?
For example if you win the lottery or a relative leaves you money this will shift liquidity preference to the right as you want to spend it. Not the same as income though.
132
How will preferences shift the demand for money? Example?
Certain cultures save more and spend less which shifts liquidity preference to the left. For example Japanese people tend to save more money. Also certain people just prefer not to carry cash for safety reasons particularly with the introduction of money substitutes.
133
How will the cost of holding money shift the demand for money?
If the opportunity cost of holding money is high then you will not hold money. For example if real estate is appreciating you will buy real estate, or if interest rates are high.
134
What are other, alternative factors that shift the demand for money?
1. Nominal interest rate 2. Real interest rate
135
What is the difference between nominal and real interest rate?
Nominal is the interest rate before inflation and real is adjusted for inflation.
136
What is a bank?
A financial intermediary that borrows money from savers and lends money to borrowers.
137
What are the three major advantages of banks?
1. High liquidity 2. Cost reduction 3. Risk reduction
138
How do banks have high liquidity?
There is a large amount of money available because they collect money from savers.
139
Why do banks reduce costs?
There is economies of scale, meaning a division of labour and borrowing and lending in large amounts.
140
Why is there reduced risks with banks?
Banks spread the risk since there are many savers and investments not just one. • Banks can research credit checks on savers • There are many banks so savers can research credibility.
141
What do banks need?
1. Capital 2. Charter (permission from the government) 3. Physical infrastructure 4. Depositors 5. Balance sheet with assets and liabilities (what the bamk owns vs what it owes)
142
What decisions are involved in banking?
How much money will be kept in the bank in the form of reserves in order to: 1. Meet the requirements of the central bank 2. Meet customers requirements with vault cash (cash kept on hand day to day) 3. Meet the reserve ratio requirement
143
What is the reserve ratio requirement?
A fraction of money that commercial banks have to keep in the central bank
144
How does a bank make a profit?
1. By investing 2. By the interest rate spread
145
What is the interest rate spread?
It is lending. The profit comes from the difference between the interest charged to people when the bank lends and the interest paid to depositors.
146
What are islamic banks?
They make profit by lending to business and receiving part of the profits since they cannot charge interest. Part of this profit is distributed to the depositors.
147
How do banks guarantee that money is safe?
Banks are insured, usually by the government
148
How much does the FDIC insure up to in the US?
250,000 dollars
149
What is a central bank?
It controls the monetary base
150
What is the monetary base?
The sum of reserves of commercial banks on deposit at the central bank, as well as vault cash as well as the money in circulation. It is legal tendr.
151
Why is the monetary base smaller than money supply?
The monetary base is smaller than the money supply because money supply includes bank money created by commercial banks.
152
How do commercial banks create bank money?
By monetizing the debt.
153
What is monetizing the debt?
The creation of money by lending. When banks lend they introduce money because it is not their money that they are lending (it is other depositors money).
154
How much money can banks create?
Only an amount equal to their excess reserves.
155
What are excess reserves?
Actual reserves - required reserves
156
What is a run on the bank?
When depositors lose trust in the bank and ask for their money back at the same time.
157
What is a monopoly bank?
idk
158
monopoly bank?
idk
159
monopoly bank?
idk
160
Why does this happen with monopoly bank?
IDK
161
What is a money multiplier?
Measures the increase in money supply for every dollar increased in the monetary base.
162
What are required reserves?
The minimum amount of deposits the bank must hold by law (10% in US)
163
What is the functions of the central bank?
1. Currency exchange 2. Lending to certain regions of sectors (usually in developing countries) 3. Setting Monetary Policy
164
How can the central bank control monetary base?
They can control it directly by printing or withdrawing money from the market.
165
How can the central bank control money supply?
It is not as easy as monetary base, quantitive and qualitative instruments are needed.
166
What are quantitative instruments?
Designed to affect the quantity of money supply in the economy such as the amount of loans.
167
What are the quantitive instruments used?
1. Reserve ratio 2. Open Market operations 3. Discount rate 4. Change in liquidity ratio (not in notes?)
168
What is the point of the reserve ratio?
To reduce inflation/deflation
169
How does the reserve ratio reduce inflation?
In order to reduce inflation the central bank will increase the reserve ration. Then excess reserves decrease and the commercial bank cannot create as much money.
170
Why is using the reserve ratio regularly not a good idea?
It is too strong an instrument. Canada, Australia and New Zealand do not have a reserve ratio.
171
What are open market operations?
When the central bank goes into the money markets and buys or sells government bonds, certificates and securities.
172
What is the point of open market operations?
1. To reduce inflation 2. To combat deflation
173
How will open market operations combat inflation and deflation?
To reduce inflation the government sells bonds because then it obtains cash which reduce excess reserves which reduces the central banks ability to make money. (I kind of get this but how does it reduce excess reserves) They will buy back bonds to put more money into the market.
174
Evaluate open market operations as an instrument to modify money supply:
They effect the monetary base precisely by putting money in and out of circulation. They are flexible, so easily reversible, and powerful because they effect money supply. All in all good.
175
What is a discount rate (in terms of a quantitive instrument)?
The rate at which the central bank lends money to private banks. It goes hand in hand with federal fund rate.
176
What is federal fund rate?
The interest rate at which commercial bank lend to each other.
177
How does the discount rate reduce inflation?
If the central bank increases the discount rate it is more expensive for commercial banks to borrow so less money is in circulation, decreasing monetary base and supply.
178
Evaluate it:
Something to do with government, ask leo
179
Of the three quantitive instruments, which is favoured?
Economists usually favour open market operations most.
180
What are qualitative instruments?
They affect the purpose for what loans are made
181
What are the qualitative instruments used by the central bank?
1. Moral suassion 2. Regulation on specific deposits and loans 3. Margin requirements
182
What is moral suassion?
The central bank has power so they suggest who to loan to
183
Why do commercial bankers listen to the central bank in moral suassion?
1. The central bank is the last resort lender 2. The central bank has the best economic information
184
What is regulation on specific deposits and loans?
An order from the central bank to increase or decrease specific interest rates for certain sectors to encourage growth in these sectors.
185
What are margin requirements?
Requirements set by the central bank specifically for loans to purchase stock in the stock market. The loaner must pay a certain percentage with their own cash, as a guarantee, effecting the amount of money lent.
186
What is the monetary transmission mechanism?
It describes how policy induced changes in the nominal price and interest rate impacts real variables such as employment rate and aggregate output. Changes in the MS and MD curve changes the MD curve.
187
monetary transmission mechanism graph
monetary transmission mechanism graph
188
stages of monetary transmission mechanism:
1. A change in the money supply or money demand changes the interest equilibrium rate. 2. This changes desired investment. 3. This changes desired expenditure, shifting the AD curve.
189
monetary transmission mechanism graph
monetary transmission mechanism graph
190
monetary transmission mechanism graph
monetary transmission mechanism graph
191
monetary transmission mechanism graph
monetary transmission mechanism graph
