Final Exam Econ 162, Kenny Christianson

Classical Dichotomy

We can separate real and nominal variables in the classical model

Real GDP depends on AS, which is determined by the real variables

Price level depends on AD, which is determined by other nominal variables

Money neutrality

In the Classical Model, changes in the money supply only affect nominal variables, but not real variables.

Say's Law

"Supply creates its own demand"

In the process of production, enough income is generated to purchase that output

If not, price level will adjust

market for loanable funds

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Crowding out effects

In the classical model, an increase in gov. Spending leads to equal and offsetting declines in consumption and investment spending.

Consumption function

A model that shows the relationship between consumption spending and disposable income in the economy

C = consumption

C0 = autonomous consumption

Y = real GDP

T = taxes

Yd = disposable income = Y-T

B = MPC = marginal propensity to consume = Change in C/Change in Yd

C = C0 + bYd

Saving function

S = -C0 + (1 - b)Yd

Import function

M = M0 + dYd

M0 = autonomous imports

d = MPIM (Marginal Propensity to Import)

d = ΔM/ΔYd

MPC

marginal propensity to consume = Change in C/Change in Yd

MPS

Marginal propensity to save = Change in S/Change in Yd

MPIM

d = MPIM (Marginal Propensity to Import)

d = ΔM/ΔYd

disposable income

C = consumption

C0 = autonomous consumption

Y = real GDP

T = taxes

Yd = disposable income = Y-T

B = MPC = marginal propensity to consume = Change in C/Change in Yd

C = C0 + bYd

Aggregate expenditures

AE=C+I+G+(X-M)

Y=AE in equilibrium

Leakages and injections

Leakages = injections

S + T + M = I + G + X

Left side = income received by households not spent on current domestic output

Right side = spending by other sectors of the economy

Spending multiplier

1/(1 - b + d) = 1/(1 - MPC + MPIM)

ΔY = 1/(1 - b + d) * ΔAE0

Tax multiplier

= (-b+d)/(1-b+d) = (-MPC + MPIM)/(1-MPC + MPIM)

ΔY = (-b+d)/(1-b+d) * ΔT

or 1-spending multiplier

Paradox of thrift

In the fixed price Keynesian model, an increase in saving leads to a decline in real GDP

Keynesian cross diagram

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Aggregate demand

Aggregate Demand (AD) (Desired Spending): A model that shows the quantity of output that spenders in the economy are willing and able to purchase at different price levels

Aggregate supply

Aggregate Supply (AS) (Desired Output): A model that shows the quantity of output that firms and workers in the economy are willing and able to produce at different price levels

Capacity utilization

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real income (wealth) effect

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Interest rate effect

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Net export effect

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Supply side economics

Classical model. Relies on microeconomics

Faith in markets

Self-adjusting mechanisms to bring economy to full employment

Long Run trends

discretionary fiscal policy

-> when the government recognizes a problem and then acts on itactive- requires a change in legislation or regulations.

-> Active- Requires a change in legislation or regulations

-> Fiscal policy LAGS

->Reconstruction LAG

Legislative LAG

Economic LAG

Automatic stabilizers

-> gov. Policies or policies that moderate fluctuations in income

GDP Gap

Potential (full employment) - Actual GDP

recessionary gap

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Budget deficit

When expenses exceed revenue

national debt

The total amount of money that the government has borrowed

Progressive tax system

Average tax rate increases as incomes increase

Proportional tax system

Tax rate is constant as income increases.

Regressive tax system

Tax rates decrease as income increases

twin deficits

When a nation has a current account deficit and a budget deficit.

Laffer Curve

relationship between economic activity and the rate of taxation that suggests an optimal tax rate that maximizes tax revenue.

M1

Most liquid, cash, checks

M2

M1 + Personal Savings

M3

M2 + Institutional savings

commodity money

A physical good with "intrinsic value"

fiat money

money that has value because the government has ordered that it is an acceptable means to pay debts

Gresham's law

bad money drives out good money

Equation of Exchange

MV=PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is the output of goods and services produced in an economy.

Quantity theory of money

Assume V and Y are constant

M V = P Y

Solve for P = MV/Y = AD Curve

YF = Full employment GDP

Monetarist model

an economic concept that contends that changes in money supply are the most significant determinants of the rate of economic growth and the behavior of the business cycle

money supply

An increase in the money supply, according to Keynes's theory, leads to a drop in the interest rate and an increase in the amount of investment that can be undertaken profitably, bringing with it an increase in total income.

Money demand

Keynes explained the asset motive through what he termed 'speculative demand'. In this theory, he argued that demand for money is a choice between holding cash and buying bonds

investment function

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Federal reserve system

the central bank of the United States

Functions of the Federal Reserve

provide financial services, supervise and regulate banking institutions, maintain the stability of the financial system, conduct monetary policy

FOMC

Federal Open Market Committee

Open market operations

The process of buying bonds from banks or selling bonds to banks to influence the quantity of bank reserves

discount lending

a type of loan, usually given for a short period, in which the person who borrows money gets an amount that is already reduced by the interest and other charges: Discount loans actually charge interest on money that the borrower never gets

reserve requirements

regulations on the minimum amount of reserves that banks must hold against deposits

informal powers

powers not laid out in the Constitution but used to carry out presidential duties

Jerome Powell

Chairman of the Federal Reserve

Term Auction Facilities

a monetary policy used by the Federal Reserve to increase liquidity in the U.S. credit markets

Federal funds rate

the interest rate at which banks make overnight loans to one another

discount rate

The interest rate on the loans that the Fed makes to banks