ECON 203 Exam 2

What do households make choices on?

Between consuming and saving their income

What do firms make choices on?

How much machinery to buy (capital investment), how many employees to employ (labor input), and how much outputs to produce that will maximize profit

What does the central bank do?

Controls the interst rate with the purpose of maximizing employment and stabilizing profits

What does a closed economy mean?

No imports or exports

Firms Production Function

Y=AK(^a)L(^1-a)

What does A represent in the firms production function?

Technology

What does K represent in the firms production function?

Capital Inputs

What does L represent in the firms production function?

Labor inputs

Growth Rate of Real GDP per capita equation

=Nominal GPD growth rate - Inflation rate - Population growth rate

What is the equation for finding a future savings or GDP amount based on the current amount and growth rate?

Savings 2035 = Savings 2025 x (1+ growth rate)^(2035-2025)

Rule of 70

Years until number doubles = (70) / (Annual growth rate %)

Productivity

A measure of the output per worker and is what drives growth

Physical capital

tangible objects

human capital

knowledge

components of productivity

physical capital, human capital, natural resources, technology

Where can savings come from?

1. within the country (household savings, government earning more money on tax revenues than their expenditures)

2. abroad

investment trade-off

increase in savings means decrease in consumption today

GDP equation

= C + I + G + NX

Foreign direct investment

when a firm runs part of its operation abroad or invests in another company abroad (EX: toyota operating a plant in the US)

foreign portfolio investment

investment funded by the foreign sources that is operated domestically (EX: foreign investors buying US stock)

Policies that enhance investment

Encourage domestic saving and investment by lowering taxes on savings and investments. Encourage foreign investments such as trade policies.

Policies that enhance human capital growth

1. Education

   1. High quality, low priced public education

   2. lower opportunity cost of education

   3. education stipends, grants, etc.

2. Health

   1. Universal healthcare

   2. Immunization

   3. Access to clean water and sanitation, etc.

What are natural resources?

Production inputs that come from the earth

renewable resources

can be replenished over time such as trees, water and electricity

nonrenewable resources

can not be replenished such as coal, oil and gold

what does technology mean?

innovations that cause the same inputs to produce more outputs. doesn’t necessarily mean a new gadget.

policies that encourage technology development

creation and dissemination of technical knowledge, research grants, patents and government research programs

growth rate of output function

= gA (growth rate of technology) + a x gK (growth rate of capital) + (1-a) x gL (growth rate of labor)

Growth rate of technology

The residual that we can attribute to technological progress

Convergence Theory

Countries that start out poor will grow faster than rich ones and will ‘converge’ to the same growth rate. Also referred to as the catch-up effect. Predicts that even if countries differ in their rates of savings, population growth, and other features. They will still converge to the same growth rate, although not the same level of income.

Factors that could impact economic growth

Enforceable laws and effective, trustworthy government services are critical to a well-functioning economy. Most countries have mechanisms to punish those who violate other’s property rights, enforce contracts between buyers and sellers, and settle disputes. Important for countries to have a stability in leadership.

Things that effect your consumption

Current income, wealth, expected future income, and interest rates

marginal propensity to consume (MPC)

the amount that consumption increases when after tax income increased by $1

hand-to-mouth households

households that spend all of their paychecks, with nothing left over to save

the wealthy hand-to-mouth households

households that have assets tied up, either as a house or in retirement accounts, so they end up spending a lot of their paycheck (high MPC)

What affects a firms investments?

Expected profits, interest rates, business taxes

What affects government spending?

Long run needs of the citizens, events out of the economy’s control

What can affect exports or imports?

Domestic income, foreign income, exchange rates, tastes or preferences for foreign foods, trade policies

What part of aggregate expenditure is affected by income?

variable consumption

consumption equation

= a + bY

Keynes and the Great Depression of the 1930s

Believed the economy remained depressed for so long because of insufficient spending. if people and firms do not spend enough, firms will not produce enough. firms produce what they can sell.

Planned Aggregate Expenditure (PAE)

total amount households, firms, government and foreigners plan to spend

planned spending = production

inventories stay unchanged

planned spending less than production

unsold goods accumulate as unintended inventory

planned spending greater than production

inventories fall unexpectedly

In the consumption equation, what does A represent?

autonomous expenditure (not affected by income)

In the consumption equation, what does b represent?

marginal propensity to consume

In the consumption equation, what does Y represent?

national income

when does equilibrium occur in aggregate expenditures?

when PAE is equal to actual aggregate expenditures.m

multiplier effect

an increase in consumer spending that occurs when spending by one person causes others to spend more too, increasing the impact on the economy of the initial spending.

multiplier equation

1/(1-b)

aggregate demand

the relationship between overall price level and the level of total demand in the economy. adding demand for everything in the economy.

wealth effect

as prices rise, households purchasing power or real wealth falls and households reduce consumption. aka real balance effect

interest rate effect

as prices rise, economic agents need more money so the demand for money rises and interest rates rise. higher interest rates make it more expensive to borrow, resulting in a decrease in investment

exchange rate effect

when US prices increase, US goods become relatively more expensive, so exports decrease and imports increase which results in net exports to decrease.

what causes movement along the aggregate demand curve?

changes in price level

what causes the aggregate demand curve to shift?

anything, other than price level, that affects C, I, G, or NX

Aggregate supply

relationship betweek the overall price level and total production by firms

long run aggregate supply

output in the economy at full capacity. potential output or full employment output. unaffected by prices.

short run aggregate supply

affected by prices. prices of final goods increase more quickly than input prices. sticky input prices

what causes a shift in long run aggregate supply?

technology innovations and changes in the quantity of factors of production (L, K natural)

what causes a shift in short run aggregate supply?

technology innovations, changes in the quantity of factors of production (L, K, natural), changes in the prices of inputs and temporary supply shocks

where does short run equilibrium occur?

at the intersection of aggregate demand and short run aggregate supply

where does long run equilibrium occur?

at the intersection of aggregate demand, short run aggregate supply and long run aggregate supply.

how can the government try to boost the economy out of a recession?

through government spending

why is increasing government spending difficult to implement in response to a recession?

difficult to gauge the overall effect, rare to perfectly design policy, and government intervention impact long run outcomes

what is the long run result of government intervention?

higher prices but output may more quickly return to long run levels

why would the government intervene in a recession?

the speed of recovery could be slow otherwise, lower prices are not always good for certain goods and services.