Midterm Flashcards
(98 cards)
1
Q
Microeconomics
A
Actions of individual agents within the economy, like households, workers, and businesses
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Macroeconomics
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Branch of economics focused on broad issues such as growth, unemployment, inflation, and trade balance
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Theory
A
Simplified representation of how two or more variables interact with each other
A good theory is simple enough to understand, while complex enough to capture the key features of the object or situation you are studying
4
Q
Model
A
Used to test a theory, for this course we will use the terms model and theory interchangeably
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Market economy
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Economy where economic decisions are decentralized, private individuals own resources, and businesses supply goods and services based on demand
6
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Law of Demand
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If price increases, quantity decreases
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Q
Ceteris paribus
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Latin phrase meaning “other things being equal”
8
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Factors affecting demand
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Something that causes a different quantity to be demanded at every price
Factors:
- Income
- Changing tastes or preferences
- Changes in the composition of the population
- Price of substitute or complement changes
- Changes in expectations about future
9
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Normal good
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Product whose demand rises when income rises
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Inferior good
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Product whose demand falls when income rises
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Substitute
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Good used in place of another good
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Complement
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Goods that are often used together so that consumption of one good tends to enhance consumption of the other
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Price ceiling
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Price is not permitted to rise (price set below EQ)
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Price floor
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Price set above EQ to prevent prices from falling
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Consumer surplus
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Amount that individuals would have been willing to pay minus the amount that they actually paid, area above the market price and below the demand curve
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Producer surplus
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Price the producer actually received minus the price the producer would have been willing to accept, area below the market price and the segment of the supply curve below the EQ
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Deadweight loss
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PS + CS that occurs when a market produces an inefficient quantity
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Law of diminishing marginal utility
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As a person receives more of a good, the additional utility from each additional unit of the good declines
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Law of diminishing returns
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As additional increments of resources to producing a good or service are added, the marginal benefit from those additional increments will decline. (Law of DMU is a more specific case of the law of diminishing returns)
20
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Production Possibilities Frontier
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Diagram that shows the productively efficient combinations of two products that an economy can produce given the resources it has available
- Slope of the PPF shows OC
21
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Comparative advantage
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When a country can produce a good at a lower OC than another country (smaller slope = comparative advantage)
22
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GDP
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Value of the output of all final goods and services produced within a country in a given year
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GDP Measured Using demand
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GDP = C + I + G + (X-M)
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GDP Measured Using Production
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Durable goods + Nondurable goods + Services (largest) + Structures + Change in inventories (typically less than 1%)
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Real GDP
Nominal GDP/ (Price Index / 100)
Price index = GDP deflator
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Real GDP Growth Rate
New real GDP - Base real GDP/ (base real gdp * 100)
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Converting GDP to a common currency
EX: Convert Brazil's GDP into US dollars
Brazil's GDP in US dollars = Brazil's GDP in reals / Exchange rate of reals to USD
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GDP per capita
GDP/population
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GDP does not include...
- Leisure time
- Actual levels of environmental cleanliness, health, and learning
- Production that is not exchanged in the market
- The level of inequality in society
- What technology and products are available
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Rule and Law of Economic Growth
Two key factors
1. Adherence to rule of law (the process of enacting laws that protect individual and entity rights to use their property as they see fit)
2. Protection of contractual rights (rights of individuals to enter into agreements with others regarding the use of their property)
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Determinants of worker productivity
Sustained long-term econ growth comes from increases in worker productivity
1. Human capital (education, skills, experience)
2. Technological change (invention and innovation)
3. Economies of scale (cost advantages that industries obtain due to size)
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Production function
Process where a firm turns economic inputs into outputs
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Aggregate production function
Economy as a whole turns inputs into output measured as GDP
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Growth Accounting Studies
Technology is typically the most important contributor to US economic growth. Human capital and physical capital explains only half or less of economic growth
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Convergence
Pattern in which economies with low per capita incomes grow faster than economies with high per capita incomes
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Unemployment rate
Percentage of adults who are in the labor force and thus seeking jobs, but who do not have jobs
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Unemployment rates by group (gender)
UE rates for men used to be lower than women, in recent decades the two have been very close, often with the UE rate for men somewhat higher
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UE rates by group - age
Highest for the very young, become lower with age
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UE Rates by group - race and ethnicity
UE rate for whites has been lower than black and hispanic in recent decades
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Cyclical unemployment
Higher unemployment during a recession
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Natural rate of unemployment
Unemployment rate that would exist in a growing and health economy from the combination of economic, social, and political factors that exist at a given time, 4.5-5.5%
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Frictional unemployment
unemployment that occurs as
workers move between jobs
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Structural unemployment
Individuals lack skills valued by employers
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Full employment
Actual unemployment rate = natural unemployment rate
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Inflation
General and ongoing rise in the level of prices in an entire economy
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Index number
Unit-free number derived from the price level over a number of years, which makes computing inflation rates easier, since the index number has values around 100
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Inflation Formula
(Level in new year - level in prior year)/ (level in prior year) *100
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CPI
Measure of inflation that US government statisticians calculate based on the price level from a fixed basket of goods and services that represents the average consumer's prices
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Substitution bias
An inflation rate calculated using a fixed basket of goods over time tends to overstate the true rise in the cost of living b/c it does not take into account that the person can substitute away from goods whose prices rise considerably
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Quality/new goods bias
Inflation measured using a fixed basket of goods over time often overstates the actual increase in the cost of living because it does not consider improvements in product quality or the introduction of new goods.
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Core inflation index
Takes the CPI and excludes volatile economic variables, like energy and food prices
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Who is hurt by inflation?
- Holding cash
- Financial asset investments where the nominal return does not keep up with inflation
- Wages lag behind inflation
- Retiree receiving a private company defined pension
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Keynes' Law
Demand creates its own supply (level of GDP in the economy is not primarily determined by the potential of what the economy can supply, but rather by the amount of total demand)
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Keynesian Zone
Portion of the SRAS curve where GDP is far below potential and the SRAS curve is flat (economy is in recession, cyclical unemployment is high, inflationary price pressure is not much of a worry)
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AD in Keynesian Analysis
- Idea that firms produce output only if they expect it to sell
- AD is not stable, it can change unexpectedly
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What determines gov spending?
Keynes recognized that the government budget offered a powerful tool for influencing AD. During extreme times like deep recessions, only the government had the power and resources to move AD.
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Keynesian view of recession
- AD is not always automatically high enough to provide firms with an incentive to hire enough workers to reach full employment
- The macroeconomy may adjust only slowly to shifts in AD b/c of sticky wages and prices
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Keynesian Policy for Fighting unemployment and inflation
Expansionary fiscal policy
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Phillips Curve
Tradeoff between unemployment and inflation (inverse relationship)
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What does the Fed do?
1. Conduct monetary policy
2. Promote stability of the financial system
3. Provide banking services to commercial banks and other depository institutions, and to provide banking services to the federal government
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Open market operations
CB buying or selling Treasury bonds to influence the quantity of money and the level of interest rates
- When Fed buys bonds, bond prices go up thus reducing interest rates
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Reserve requirement
% of each bank's deposits that it is legally required to hold either as cash in their vault or on deposit with the central bank (greater reserve requirement = less money available to lend out)
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Discount rate
Interest rate charged by the central bank on the loans that it gives to other commercial banks (increase = commercial banks reduce their borrowing from fed and money supply falls, market interest rates rise)
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Federal funds rate
Interest rate at which one bank lends funds to another bank overnight
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Expansionary monetary policy
Shifts the money supply to the right
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Quantitative easing
Purchase of long term government and private mortgage-backed securities by central banks to make credit available in hopes of stimulating aggregate demand (used in 2008)
- Different b/c purchasing long term Treasury bonds rather than short term Treasury bills
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Say's Law
Say’s Law states that supply creates its own demand, meaning that producing goods and services generates the income needed to purchase them. It suggests that economies naturally reach equilibrium without persistent demand shortages, though Keynesian economics later challenged this idea.
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The difference between Say’s Law and Keynesianism
Say’s Law argues that supply creates its own demand, meaning production naturally generates enough income to sustain economic equilibrium. Keynesianism counters this by asserting that demand drives the economy, and without sufficient consumer spending, recessions and unemployment can persist, requiring government intervention.
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Monetary Systems Before and After the War
Before: most were on the Gold Standard (currencies backed by gold, ensuring fixed exchange rates and monetary stability, limited inflation but restricted governments' ability to respond to economic crises)
After: Bretton Woods System replaced the Gold Standard, pegging global currencies to the US dollar, which was convertible to gold, this system promoted stability but collapsed in 1971, leading to the floating exchange rate system, where currency values fluctuate based on market forces
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Great Depression
Took place mostly during the 1930s, originating in the US, 1929-1941
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Causes of the Great Depression
- Farm Depression of the 1920s (farmers producing more than American consumers were consuming)
- Purchasing power (overproduction in industry, too few workers could afford to buy the factory output)
- Uneven distribution of income
- Trade collapses (high tariffs and war debts)
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Establishment of Fed
Created in 1913 to help stabilize the economy by establishing a central banking system for the US
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The Gold Standard as a Monetary System
The Gold Standard is a monetary system in which a country's currency is directly linked to a fixed quantity of gold. Under this system, paper money can be exchanged for gold at a predetermined rate, ensuring price stability and fixed exchange rates between countries.
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Pros of the Gold Standard
- More trade among the countries in the gold standard
- Certified governments --> repay without devaluations of currencies
- Predictable rules (fixed exchange rates)
- Monetary order around global finance (increases trust in currency)
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Cons of Gold Standard
Under the Gold Standard, **deflation** occurred due to limited gold supply and its movement between countries. Monetary policy **lacked flexibility**, restricting changes to the money supply. In a crisis, countries faced a tough choice: r**aise interest rates to retain gold (slowing growth) or let gold leave (risking currency instability)**. This dilemma worsened the Great Depression—some tightened policy, deepening the downturn, while others abandoned the Gold Standard to restore monetary flexibility.
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Exchange rate definition
Exchange rates are the value of one country's currency in terms of another currency, determining how much of one currency is needed to buy another.
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Exchange rate fluctuations
- Exchange rates can fluctuate substantially, even between bordering countries such as the US and Canada
- Frequent substantial fluctuations in the exchange rate can disrupt international trade and cause problems in a nation's banking system
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Causes of Exchange Rate Fluctuations
- Interest rates
- Inflation (lower inflation = stronger currency)
- Trade balance (strong exports --> high demand for currency, boosting value)
- Political stability
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Exchange rate policies
Exchange rate regimes/policies determine how a country manages its currency relative to others.
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Floating exchange rate
A country lets the exchange rate market determine its currency's value (US dollar is a floating exchange rate)
- Major concern = exchange rates can move a great deal in a short time
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Soft peg
An exchange rate policy in which the government usually allows the market to set the exchange rate, but in some cases, especially if the exchange rate seems to be moving rapidly in one direction, the central bank will intervene
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Hard Peg
An exchange rate policy in which the central bank sets a fixed and unchanging value for the exchange rate
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Merged currency
Nation chooses to use another nation's currency (eliminates foreign exchange risk, nation has given up on domestic monetary policy)
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Unholy trinity in economics
A country cannot simultaneously achieve all three of the following:
- Be open to international capital flows
- Control its domestic interest rate
- Fix its exchange rate (peg currency)
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Policymaker's Choice
Policymakers must choose 2 of these 3 options in the unholy trinity based on their economic priorities
Option 1: Fixed Exchange Rate + Free Capital Flows (No Monetary Independence) --> Hong Kong
Option 2: Free Capital Flows + Monetary Independence (No Fixed Exchange Rate) --> US, Eurozone
Option 3: Fixed Exchange Rate + Monetary Independence (No Free Capital Flows, Use of Capital Controls) --> China
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Benefits of Open Capital Markets
- Capital flows to its most efficient uses.
- Encourages investment and economic growth.
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Risks of Open Capital Markets
- Financial instability can spread quickly across countries.
- Emerging markets are particularly vulnerable to sudden capital flight.
- Rapid outflows can drive down bond prices, increase interest rates, and devalue the currency, leading to crises similar to bank runs.
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Capital Controls as a Policy Response
Government-imposed measures that regulate the flow of money into and out of a country to manage economic stability.
- Inflow Controls: Restrictions on foreign investment to prevent excessive capital from entering the economy, which can lead to inflation or asset bubbles.
- Outflow Controls: Limits on investors moving money abroad to prevent capital flight, currency depreciation, or financial crises.
- Often include prohibitions on domestic residents purchasing foreign assets or moving currency abroad.
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Why do states sometimes opt for fixed exchange rates?
- Simplify operations for businesses that trade internationally
- Reduce the risk that investors face when they hold foreign stocks and bonds
- Ties policymakers' hands (in countries prone to bouts of high inflation, fixed exchange rate may be the only way to establish a credible low-inflation policy)
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Risks of a fixed exchange rate
- Fragile and prone to type of crisis called a speculative attack
- If financial market participants believe that the government will soon devalue its currency, investors will likely act preemptively by selling off the currency. This speculative attack can accelerate the process, forcing an immediate devaluation.
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Bretton Woods System Overview
The Bretton Woods System (1944–1971) was a global monetary framework established after World War II to ensure economic stability and prevent currency crises.
- System of fixed exchange rates that offered more policy flexibility over the short term than had been possible under the gold standard
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Key features of Bretton Woods System
- Fixed Exchange Rates: Currencies were pegged to the U.S. dollar, which was convertible to gold at $35 per ounce.
- U.S. Dollar as the Anchor: The U.S. held the majority of the world's gold reserves, making the dollar the primary global reserve currency.
- International Monetary Institutions: Created the International Monetary Fund (IMF) to provide financial stability and the World Bank to fund reconstruction and development.
- Limited Monetary Policy Independence: Countries could adjust their currency values only in cases of "fundamental disequilibrium" to prevent economic collapse.
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Collapse of Bretton Woods
1971, The U.S. ran persistent trade deficits, and foreign governments held more dollars than the U.S. had gold to back them. In 1971, President Nixon suspended gold convertibility, leading to the system’s collapse and the shift to floating exchange rates.
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Why did the economy boom after WWII?
- Military spending or Keynesianism
- Permanent war economy
- Infrastructure spending (Traditional Keynesianis)
- The role of institutions (America imposing its economic view on the non-communist world)
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What was the paradigm shift?
- Following election of Reagan and Thatcher, neoliberal view took hold
- State's economic role was drastically diminished to a guarantor of stable economic conditions, alongside significant reductions in taxes and spending
- Led to lower inflation but higher income inequality
- More financial deregulation, leading to periodic crises (ie 2008)
- Shift from manufacturing to service-based economies
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Why was Thatcher so influential in British political economy?
- Shifted the British economy by shifting it from a state-controlled, welfare-based model to a free-market, neoliberal system
- Rejected state intervention and argued for free markets
- Privatization of state-owned industries
- Weakening of trade unions
- Shift to monetarist economic policies (prioritizing inflation control over full employment)
- Deregulation and financial liberalization (allowed more foreign investment, fueling economic growth but also financial inequality)
- Tax cuts and reduction of welfare state
Long term: Revitalized economy but increased wealth inequality, stronger private sector but weakened manufacturing, permanently shifted UK politics
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Issues during Thatcher's time in office
- Economic crisis and high unemployment (focused on inflation control rather than job creation)
- Power of trade unions (passed anti-union laws)
- Privatization of state-owned industries (launched mass privatization, encouraged citizens to buy shares in former public companies --> increase in revenue and gov't revenue but led to job losses and wealth inequality)
- Falklands War (Argentina, reclaim the land with military action)
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Approach toward EU
Margaret Thatcher **supported economic integration** within the EU but strongly **opposed political union**. She backed the Single European Market for free trade and helped pass the Single European Act (1986) to promote competition. However, she **resisted deeper political ties** and secured a rebate on the UK’s EU contributions in 1984 to reduce financial strain. She **opposed the euro**, fearing it would undermine Britain’s monetary control. Her skepticism **shaped Conservative Party attitudes toward the EU**, influencing later debates on **Brexit**.
