finals

marginal propensity to consume (MPC)

the increase in consumer spending when disposable income increases MPC \= change in consumer spending / change in disposable income

marginal propensity to save (MPS)

the fraction of an additional dollar of disposable income that is saved

multiplier

the ratio of total change in real GDP caused by an autonomous change in aggregate expenditure to the size of that autonomous change formula: (1 / 1- MPC)

autonomous change in aggregate expenditure

an initial rise or fall in aggregate expenditure at a given level of real GDP leads to the multiplier effect

holding everything else constant in an economy, the larger the MPS, the….

smaller the value of the multiplier

consumption function

an equation showing how an individuals household’s consumer spending varies with the household’s disposable income c \= ac + MPC x yd

when yd increases by $1

c goes up by MPC x $1

aggregate consumption function

the relationship for the economy as a whole between aggregate disposable income and aggregate consumer spending C \= AC + MPC x YD

what does the expectation of higher income in the future do to aggregate consumption?

rise it

what does the expectation of less income in the future do to aggregate consumption?

lower it

what does the rise in total wealth (for the public) do to aggregate consumption?

rise it

what does the fall in total wealth (for the public) do to aggregate consumption?

lower it

life-cycle hypothesis

economic theory that describes the spending and saving habits of people over the course of a lifetime. The theory states that individuals seek to smooth consumption throughout their lifetime by borrowing when their income is low and saving when their income is high

planned investment spending

the investment spending that businesses intend to undertake during a given period

what does planned investment spending depend on?

interest ratesexpected future real GDPcurrent level of production capacity

retained earnings

past profits used to finance investment spending

a firm shouldn’t be looking for investment opportunities if…

their production isn’t at full potential (maximum productivity)

the higher the current capacity….

the lower the investment spending

accelerator principle

the proposition that a higher growth rate in real GDP results in a higher level of planned investment spending, and a lower growth rate in real GDP leads to lower planned investment spending

inventories

stocks of goods held to satisfy future sales

inventory investment

the value of change in total inventories held in the economy during a given period

unplanned inventory investment

unplanned changes in inventories that occur when actual sales are more or less than businesses expected

actual investment spending

planned investment spending + unplanned investment spending so in any period, I \= I unplanned + I planned

planned aggregate expenditure

the total amount of planned spending in the economy; includes consumer spending and planned investment spending AE planned \= C + I planned

if firms overestimated sales and produced too much…

there will be unintended additions to inventories, thus I unplanned is positive

if firms underestimated sales and produced too little…

there will be unintended drops in inventories, thus I planned is negative

whenever real GDP exceeds AE planned…

I unplanned is positive

whenever real GDP is less than AE planned…

I unplanned is negative

income-expenditure equilibrium

when aggregate output (real GDP) is equal to planned aggregate expenditure

income-expenditure equilibrium GDP

the level of real GDP at which real GDP equals planned aggregate expenditure

aggregate demand curve (AD curve)

shows the quantity of all goods and services demanded in the economy at any given price level

wealth effect (of a change in the aggregate price level)

when price increases, consumer spending drops because people buy fewer things than they were able to before w/ the same amount of money

interest-rate effect (of a change in the aggregate price level)

when price increases, buying stuff costs more money in order. in order to still afford this stuff, people would sell their accumulated wealth (savings); this then drives the interest rate up

when the aggregate price level changes…

the AE planned curve shifts when prices drop, people spend a lot more than they usually would. this then leads to a multiplier effect (which raises real GDP)

factors that cause the aggregate demand curve to shift right (increase)

when consumers and firms become more optimisticwhen real value of households’ wealth increasesexisting stock of physical capital is relatively smallgovernment increases spending or cut taxescentral bank increases the quantity of money

factors that cause the aggregate demand (AD) curve to shift left (decrease)

consumers and firms become more pessimisticreal value of households’ wealth decreasesexisting stock of physical capital is relatively largegovernment decreases spending and raise taxeswhen central banks reduces the quantity of money

when there is a change in price level….

the is movement ALONG the AD curve, NOT SHIFT

aggregate supply curve (AS curve)

shows the relationship between the aggregate price level and and the quantity of aggregate output producers are willing to supply in the economy there are short run and long run aggregate supply curvesin the short run it’s upward sloping, becomes vertical in the long run

nominal wages are…

sticky in the short run

nominal wages

the dollar amount of wage paid

sticky wages

nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labour shortages e.g. during the Great Recession of 2008, nominal wages didn’t decrease, due to the stickiness of wages

factors that shift the aggregate supply (AS) curve to the right (increases)

when commodity prices fallwhen nominal wages fallwhen workers become more productive

factors that shift the aggregate supply (AS) curve to the left (decreases)

when commodity prices risewhen nominal wages risewhen workers become less productive

in the long run, prices will have

no effect on aggregate output because prices (including nominal wages) are now fully flexible

how do sticky wages affect the short run aggregate supply curve (SRAS)?

profit per unit \= price per unit - production cost per unit

potential output

is the level of real GDP the economy would produce if all prices, including nominal wages, were fully flexible the level of real GDP is always either above or below the potential output because of short run fluctuations

AD-AS model

uses the aggregate supply curve and and the aggregate demand curve together to analyze economic fluctuations

short-run macroeconomic equilibrium

when the quantity of aggregate output supplied is equal to the quantity demanded

short-run equilibrium aggregate price level

aggregate price level in the short-run macroeconomic equilibrium

short-run equilibrium aggregate output

quantity of aggregate output produced in the short-run macroeconomic equilibrium

demand shock

event that shifts the aggregate demand curve

supply shock

event that shifts the aggregate supply curve

positive demand shock

leads to a higher aggregate price level and higher aggregate output

negative demand shock

leads to a lower aggregate price level and lower aggregate output

positive supply shock

leads to a higher aggregate output and a lower aggregate price level

negative supply shock

leads to lower aggregate output and a higher aggregate price level causes a rise in unemployment

in the long run equilibrium…

the economy will reach potential output in the long run, so potential output \= LRAS (a vertical line)

recessionary gap

when aggregate output is below potential output (AE < AE p or Y < Y p)

inflationary gap

when aggregate output is above potential output (AE \> AE p or Y \> Yp)

output gap

the percent difference between actual aggregate output and potential output (actual aggregate output - potential output/ potential output) x 100

short run effects of a negative demand shock

shifts AD curve leftwarda recessionary gap arisesaggregate price level and aggregate output both declineunemployment rises

long run effects of a negative demand shock

nominal wages will fall in response to high unemploymentSRAS shifts rightward

short run effects of a positive demand shock

shifts AD curve rightwardcreates an inflationary gapaggregate price levels & aggregate output increasesunemployment falls

long run effects of a positive demand shock

nominal wages will rise because of low unemploymentSRAS shifts leftwardseconomy returns to long run macroeconomic equilibrium

stabilization policy

the use of government policy to reduce the severity of recessions and rein excessively strong expansions

stabilization of unemployment

requires an increase in aggregate demand; increases inflation

stabilization of prices

decreases in aggregate demand; leads to higher unemployment

social insurance

government programs that protect families against economic hardship example: CPP

in government purchases…

health care and education are the biggest categories

in governmental transfers…

social services (CPP, QPP) are the biggest categories

since government can affect spending by consumers and firms

it can shift the demand curve the government controls G and indirectly affects C and I (from the GDP formula)

fiscal policy

the use of taxes, governmental transfers, or government purchases of goods and services to shift the aggregate demand curve

expansionary fiscal policy

fiscal policy that increases aggregate demand the increase in governmental spendingcut in taxesincrease in governmental transfers

contractionary fiscal policy

fiscal policy that decreases aggregate demand reduction in government purchases of goods and servicesincrease in taxesreduction in governmental transfers

does government spending always crowd out private spending?

NO because: resources aren’t always fully employedaggregate income is not fully fixedexpansionary fiscal policies puts underemployed resources to work which generates higher spending and higher income

does government spending always crowd out private investment spending?

NO because: crowding out doesn’t happen when economy is depressedin a depressed economy, a fiscal expansion will lead to higher incomes therefore greater savings

ricardian equivalence theorem

the proposition that an increase in government spending as no effect on aggregate demand

automatic stabilizers

government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands

what is the most important example of automatic stabilizer?

taxes that depend on disposable income

discretionary fiscal policy

fiscal policy that is the direct result of deliberate actions by policy makers rather than automatic adjustments or rules opposite of an automatic stabilizer

multiplier effect for taxes or transfers is….

SMALLER than the multiple effect for CHANGES IN AGGREGATE SPENDING

cyclically adjusted budget balance

fiscal policy that is the direct result of deliberate actions by policy makers rather than automatic adjustments or rules

should the budget be balanced?

not really a government should balance its budget on average \-- meaning it is okay to have some years with budget deficits if you can balance it out with other years with budget surpluses

public debt

government debt held by individuals and institutions outside the government

deficit

difference between the amount of money a government spends and the amount of money it receives in taxes OVER A PERIOD OF TIME

debt

is the sum of money a government owes at a particular time

crowding out

when an economy is at full employment, budget deficits may raise interest rates, crowd out private investment spending, and reduce the economy’s long run growth

debt spiral

when the interest on government debt drives that debt even higher

debt-GDP ratio

government debt as a percentage of GDP, frequently used as a measure of a government’s ability to pay its debts

implicit liabilities

spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics can cause long run budget issues with countries like Canada, Japan, and the USA

money

any asset that can be used to purchase goods and services easily must function as a medium of exchange, store of value and a unit of account

currency in circulation

cash held by the public

chequable bank deposits

bank accounts on which people can write cheques

money supply

total value of financial assets in the economy that are considered money

medium of payment

something people accept as payment for goods and services

store of value

money is a means of holding purchasing power over time

unit of account

money provides a yardstick for measuring and comparing the values of a wide variety of goods and services

commodity of money

a good, normally gold or silver, used as a medium of exchange that has no intrinsic value in other uses

commodity-backed money

a medium of exchange with no intrinsic value with the ultimate promise that it can be converted into valuable goods (like gold and silver) held up viewer resources