ECO 3307 - Exam 3

What is the mathematical definition of fiscal multiplier?

∆Y/∆G

What is the fiscal multiplier?

changes in real GDP due to changes in government purchases

What is macroeconomic stabilization?

Use of monetary and fiscal policy to adjust AD to smooth out business cycle

Difference between fiscal and monetary policy

fiscal policy involves changing taxation and government spending and is run via congress

monetary policy involves changes to money supply and is run via the central bank

Identify the shift when money supply increases in Keynesian model

LM curve shifts right

Identify the shift when money supply decreases

LM curve shifts left

Identify the shift when money demand increases

When money demand increases, LM shifts left

Identify the shift when money demand decreases

When money demand decreases, LM shifts right

What increases money demand?

a decrease in expected inflation

Identify the shift when price increases

When price increases, LM shifts left

When might price increase?

Due to inflation

Identify the shift when C, G, or I increase

IS shifts right

Which direction does AD shift when IS shifts right

Right

Which direction does AD shift when LM shifts right due to money supply shocks

right

Through what mechanism does AD shift when LM shocks occur

AD shifts as a result of changes to interest rate

Why does IS slopes downward?

IS slopes downward because there is an inverse relationship between interest and real GDP. For example, when the savings curve shifts to the right, GDP increases and interest rate decreases. To connect these points, the IS curve must slope down.

Technical definition of a recession

Two consecutive quarters of contraction

Procyclical variables

GDP, stock prices, government purchases, employment, inflation, investment, durable good spending, average labor productivity, real wage

examples of countercyclical variables

unemployment, business failure

acyclical variables

have no clear pattern

three factors that increase consumption demand

1. expected increase in future income

2. tax cut without ricardian equivalence

3. increase in wealth

Definition of short run equilibrium

point where savings and investment market and money markets are both in equilibrium at the current P

Two main factors that affect FE

shocks to labor supply or labor demand

four factors that shift labor supply left

1. reduction in labor force participation rate

2. reduction in working age population

3. changes to future expectations

4. increase in wealth

factors that shift labor demand left

1. reduction in productivity

2. reduction to capital

What is the difference between temporary and permanent productivity shocks?

temporary productiv

Why does a decrease in taxes cause IS to shift right?

a decrease in taxes increases return on investment which increases I

The idea that the business cycle is recurrent means that

the standard pattern of contraction-trough-expansion peak occurs again and again in industrial economies

How does future marginal productivity of capital (MPKf) affect the labor market?

an expected increase has no affect on the labor market

an actual increase causes marginal productivity of labor to increase which would thus shift FE right

Why is average labor productivity misrepresented in the Keynesian model?

ALP should be procyclical, but according to the Keynesian model it is countercyclical. This is because when AD increases, companies hire more workers to meet demand, but there is a diminishing return so average labor productivity decreases as Y increases

Why don’t firms change their prices in the SR?

the cost of changing prices might exceed the additional revenue the price change would generate

Why does macroeconomic stabilization often fail?

1. lag between the implementation of a stabilization policy and when that policy has an effect

2. difficult to predict the quantitative effect a policy will have on output

3. estimates of how far the economy is from FE is often inaccurate or subject to data revisions

What does it mean that the business cyclce isn’t periodic?

it doesn’t occur at regular, predictable intervals

What does it mean that the business cycle is persistent?

Declines are followed by further declines and growth is followed by growth

leading variables

investment, labor productivity, and stock prices

coincident variables

production, consumption, employment

lagging variables

inflation and nominal interest rates

volatile variables

durable goods and investment

limitations of leading indicators

1. data is often revised

2. can give false warnings

3. index provides little info on the timing of the recession or its severity

What do classicals identify as the main reason for fluctuations in output?

aggregate supply shocks

what two things cause aggregate supply shocks

productivity and labor supply changes

identify the impact of aggregate supply shocks

they shift FE and LRAS

what three things shift FE to the right

1. beneficial supply shock

2. an increase in labor supply

3. an increase in capital stock

why does the savings curve have a positive slope

higher real interest rate increases saving

why does investment curve slope downward

higher interest rate reduces the desired capital stock, thus reducing investment

6 things that shift IS to the right

1. increase in expected future output

2. an increase in wealth

3. a temporary increase in government purchases

4. a decline in taxes

5. an increase in expected MPKf

6. a decrease in effective tax rate on capital

IS curve is in the _____ market

goods

LM curve is in the _______ market

asset/money

why is lm curve upward sloping

higher Y increases demand for money supply which increases interest rates

8 things that shift LM curve right

1. an increase in nominal money supply

2. a decrease in price level

3. an increase in expected inflation

4. a decrease in the nominal interest rate on money

5. a decrease in wealth

6. a decrease in the risk of alternative assets relative to the risk of holding money

7. an increase in liquidity of the alternative assets

8. an increase in the efficiency of payment technologies

Why is the FE line vertical?

The level of output at full employment doesn’t depend on the real interest rate

What does it mean for money to be neutral?

a change in nominal money supply changes the price level proportionately but has no effect on real variables

What is the classical view of money neutrality?

money neutrality holds in short run and long run

keynesian view of money neutrality

money is neutral in the long run, but not in the short run

what does the AD curve describe?

relates the total quantity of goods demanded to the general price level, not a relative price

why does AD curve slope downward?

a higher price level is associated with lower real money supply which raises the interest rate and decreases output demanded

what is the source of unemployment in the classical model?

mismatches between workers and firms

reasons for real wage rigidity

1. minimum wage and labor unions

   1. less plausible for the US

2. pay higher wages to avoid turnover costs

3. higher wages increases productivity

efficiency wage model

1. workers that are well treated work harder and more efficiently

2. workers won’t risk losing a well paying job

what is the shape of the effort curve? (effort vs wage)

s shaped

definition of efficiency wage

the wage at which firms can maximize the effort from workers for each dollar of real wages paid