ECON 209 - Mastery Deck

What is Gross Domestic Product (GDP)?

The market value of all final goods and services produced within a country in a given period.

What does GDP measure?

The total production, total expenditure, and total income within an economy.

What is the expenditure approach to calculating GDP?

GDP = C + I + G + (X - IM), where C = consumption, I = investment, G = government spending, X = exports, IM = imports.

What does each letter represent in GDP = C + I + G + (X - IM)?

C = consumption; I = investment; G = government spending; X = exports; IM = imports.

What is the income approach to GDP?

Sum of factor incomes earned by households and businesses: wages + interest + rent + profits.

Define potential GDP (Y*).

The level of GDP when all resources (labour, capital) are fully employed at normal levels.

What is the difference between nominal and real GDP?

Nominal GDP is measured at current prices; real GDP is adjusted for inflation.

What is Aggregate Expenditure (AE)?

The total planned spending on final goods and services at a given level of income.

What is the basic AE model equilibrium condition?

Equilibrium occurs when AE = Y (planned expenditure equals actual output).

How does the 45-degree line in AE diagrams relate to equilibrium?

It shows all points where planned spending equals actual output.

What happens if AE > Y?

Inventories fall, prompting firms to increase production, raising GDP.

What happens if AE < Y?

Inventories rise, prompting firms to cut production, lowering GDP.

What is the saving-investment equilibrium condition in a closed economy?

Equilibrium occurs when desired saving (S) equals desired investment (I).

Formula for saving in a simple model.

S = Y - C, where Y = income and C = consumption.

How does saving relate to equilibrium GDP?

When S = I, the economy is in equilibrium; otherwise, GDP will adjust.

What is national saving in an open economy with government?

National saving = Private saving + Public saving = (Y - T - C) + (T - G).

Saving-Investment condition in an open economy.

S + (T - G) = I + (X - IM), meaning national saving finances investment and net exports.

Interpretation: What does (X - IM) > 0 mean?

A current account surplus; the country is lending to the rest of the world.

Interpretation: What does (X - IM) < 0 mean?

A current account deficit; the country is borrowing from the rest of the world.

What shifts the AE curve upward?

Increases in autonomous consumption, investment, government spending, or net exports.

What shifts the AE curve downward?

Decreases in autonomous consumption, investment, government spending, or net exports.

Define Marginal Propensity to Consume (MPC).

The fraction of an additional dollar of income that is spent on consumption.

Define Marginal Propensity to Save (MPS).

The fraction of an additional dollar of income that is saved. MPS = 1 - MPC.

How is the simple multiplier calculated?

Multiplier = 1 / (1 - MPC) in a closed economy without taxes.

How does the multiplier change in an open economy with taxes?

Multiplier = 1 / (1 - (MPC × (1 - t)) + m), where t = tax rate and m = marginal propensity to import.

What is government expenditure (G) in the GDP equation?

Spending by the government on goods and services, excluding transfer payments.

What are transfer payments?

Payments like pensions, unemployment insurance, and welfare, which are not made in exchange for goods or services.

How do taxes (T) affect the AE function?

Taxes reduce disposable income (YD), thereby lowering consumption and aggregate expenditure.

Formula for disposable income (YD).

YD = Y - T, where Y = national income and T = net taxes.

How do exports (X) affect aggregate expenditure?

Exports add to aggregate expenditure because they represent foreign demand for domestic goods.

How do imports (IM) affect aggregate expenditure?

Imports subtract from aggregate expenditure because they represent spending on foreign goods.

Formula for net exports (NX).

NX = X - IM (exports minus imports).

What shifts the net exports function?

Changes in foreign income, domestic income, exchange rates, and trade policies.

Effect of an increase in foreign income on exports.

An increase in foreign income raises exports, shifting AE upward.

Effect of an increase in domestic income on imports.

An increase in domestic income raises imports, reducing net exports and shifting AE downward.

Define Marginal Propensity to Import (m).

The fraction of an additional dollar of income spent on imports.

What is the AE formula in an open economy with government?

AE = C + I + G + (X - IM), where C, I, G are functions of disposable income.

What is the government spending multiplier?

Multiplier = 1 / (1 - MPC(1 - t) + m), where t = tax rate and m = marginal propensity to import.

Effect of higher taxes (t) on the multiplier.

A higher tax rate reduces the multiplier because it reduces disposable income and consumption.

Effect of a higher marginal propensity to import (m) on the multiplier.

A higher propensity to import reduces the multiplier because more income leaks abroad.

Define the balanced budget multiplier.

The change in equilibrium GDP caused by an equal increase in government spending and taxes.

Value of the balanced budget multiplier.

It is equal to 1, assuming MPC is between 0 and 1.

Why is the balanced budget multiplier exactly 1?

Because the direct increase in G fully offsets the reduction in C caused by the increase in T.

What happens to equilibrium GDP if exports increase?

An increase in exports shifts AE upward, increasing equilibrium GDP.

What happens to equilibrium GDP if imports increase autonomously?

An increase in autonomous imports shifts AE downward, decreasing equilibrium GDP.

How do tariffs or trade restrictions affect net exports and GDP?

They can reduce imports, increase NX, and shift AE upward temporarily.

How does an appreciation of domestic currency affect net exports?

Appreciation makes exports more expensive and imports cheaper, reducing net exports and shifting AE downward.

How does a depreciation of domestic currency affect net exports?

Depreciation makes exports cheaper and imports more expensive, increasing net exports and shifting AE upward.

What is economic growth?

An increase in the productive capacity of an economy, usually measured as growth in real GDP per capita.

What is potential output (Y*)?

The level of output the economy can produce at full employment of its resources without inflationary pressure.

What are the three main sources of economic growth?

Growth of the labour force, growth of human and physical capital, and technological progress.

What is labour productivity?

Output per worker or per hour worked; a key driver of long-run economic growth.

Define capital deepening.

An increase in the amount of capital per worker, leading to higher productivity.

What is total factor productivity (TFP)?

The portion of output not explained by the amount of inputs used; it captures effects of technological progress.

How do you calculate the average annual growth rate?

[(Final Value / Initial Value)^(1/number of years)] - 1.

What is the Rule of 72?

An approximation to estimate how many years it takes for a variable to double: 72 divided by the growth rate.

Using the Rule of 72: if GDP grows at 3% annually, how long to double?

Approximately 24 years (72 / 3 = 24).

What is the neoclassical growth model?

A model emphasizing diminishing returns to capital and predicting convergence between rich and poor countries if they have similar access to technology.

What is the Solow residual?

A measure of total factor productivity growth, i.e., output growth unexplained by input growth.

What is the endogenous growth theory?

A theory that technological progress is driven by economic incentives and investment in human capital, rather than being purely external.

Key difference between neoclassical and endogenous growth models.

Neoclassical assumes diminishing returns and external technological change; endogenous growth models allow increasing returns and technology as an internal outcome.

Why is technological progress important for long-run growth?

Because it allows continued increases in output per worker even when capital deepening faces diminishing returns.

What factors influence total factor productivity?

Innovation, education, quality of institutions, research and development (R&D), and infrastructure.

How does education impact growth?

Education improves human capital, raising worker productivity and fostering technological innovation.

How does infrastructure affect growth?

Better infrastructure (roads, electricity, internet) enhances productivity and reduces transaction costs.

What is catch-up growth?

Rapid growth experienced by poorer economies as they adopt existing technologies from richer economies.

What are diminishing returns to capital?

Each additional unit of capital adds less to output when the economy already has a lot of capital.

What is convergence in economic growth?

The hypothesis that poorer economies will tend to grow faster than richer ones and thus converge in income levels over time.

What are the three functions of money?

Medium of exchange, store of value, and unit of account.

Define medium of exchange.

An item that buyers give to sellers when they want to purchase goods and services.

Define store of value.

An item that people can use to transfer purchasing power from the present to the future.

Define unit of account.

A standard unit for quoting prices and recording debts.

What is the money supply (Ms)?

The total quantity of money available in the economy.

What is the central bank of Canada?

The Bank of Canada.

How do commercial banks create money?

Through the process of accepting deposits and making loans, expanding the money supply.

What are reserves?

Deposits that banks have received but have not loaned out.

What is the reserve ratio?

The fraction of deposits that banks hold as reserves.

What is the money multiplier formula?

Money multiplier = 1 / reserve ratio.

What is monetary policy?

The process by which the central bank manages the money supply and interest rates to influence the economy.

What is the overnight interest rate?

The rate at which major financial institutions borrow and lend one-day (overnight) funds among themselves.

How does the Bank of Canada control the overnight rate?

By setting a target and providing a lending rate 0.25% above and a deposit rate 0.25% below the target.

Why does the Bank of Canada target the interest rate rather than the money supply?

Because it allows more predictable control of monetary conditions and easier communication with the public.

What is an open-market operation?

The buying and selling of government securities by the central bank to control the money supply.

Define expansionary monetary policy.

Lowering the target overnight rate to stimulate investment and consumption, raising GDP.

Define contractionary monetary policy.

Raising the target overnight rate to reduce inflationary pressures.

What is the monetary transmission mechanism?

The process through which monetary policy actions affect aggregate demand and the economy.

Stages of the monetary transmission mechanism.

1. Changes in money supply/demand change interest rates → 2. Changes in investment and consumption → 3. Shifts in aggregate demand.

In an open economy, what is an additional channel of the monetary transmission mechanism?

Changes in interest rates affect the exchange rate, influencing net exports.

Why is the money supply endogenous?

Because the money supply adjusts in response to economic activity and bank lending behavior.

When does the Bank of Canada perform open-market operations?

To accommodate changing demand for reserves and keep the overnight rate close to the target.

What is the short-run effect of expansionary monetary policy?

Lower interest rates stimulate investment, increasing aggregate demand and output.

What is the long-run neutrality of money?

The idea that changes in the money supply affect prices but not real GDP in the long run.

Define hysteresis in the context of monetary policy.

The idea that prolonged periods of unemployment can reduce potential output by eroding workers' skills.

What is inflation?

A sustained increase in the general price level of goods and services.

What is the Consumer Price Index (CPI)?

An index that measures the average change over time in the prices paid by consumers for a basket of goods and services.

Define output gap.

The difference between actual output (Y) and potential output (Y*).

What is a positive output gap?

When actual GDP (Y) is greater than potential GDP (Y*), causing upward pressure on wages and inflation.

What is a negative output gap?

When actual GDP (Y) is less than potential GDP (Y*), causing downward pressure on wages and inflation.

What is NAIRU?

The Non-Accelerating Inflation Rate of Unemployment; the unemployment rate at which inflation is stable.

Relationship between output gaps and unemployment.

When Y > Y, unemployment < NAIRU; when Y < Y, unemployment > NAIRU.