UMN ECON 1102 Midterm 2 Study

Flashcards covering the key concepts from ECON 1102 Midterm 2 lecture notes.

Loanable funds market sellers

Savers with cash on hand willing to put aside money for a price (interest rate).

Loanable funds market buyers

Firms and the government who do not have current funds available for purchases/investment in capital growth.

Price in the market for loanable funds

Interest rate.

Effect of increased sales tax

Lower consumption; savings increased, interest rate decreased, quantity of loanable funds increases.

Time preference effect on savings

Affects the desire to have goods and services sooner; more patient leads to a higher savings rate.

Interest rate effect on savings

Higher interest rates make individuals more likely to save due to increased returns.

Smooth consumption

Desire to consume a similar amount throughout one's lifetime.

Impact of smooth consumption on savers

Helps maintain a standard of living throughout retirement despite fluctuating income.

Impact of smooth consumption on borrowers

Allows consumption greater than income, spreads out sacrifices.

Determinants of supply of loanable funds

Culture, social welfare policies, wealth, current economic conditions, expectations about future economic conditions.

Determinants of demand for loanable funds

Changes in perceived business opportunities, government borrowing, tradeoff between costs of borrowing and potential benefits.

Effect of present value on interest rates

As bond price increases, interest rate decreases.

No free lunch principle

No additional reward can be achieved without additional risk.

Crowding out effect

Decrease in private spending when the government borrows more.

Effects of crowding out

Increased interest rate, increased savings, decreased consumption, decreased investment.

Bond definition

A sophisticated IOU that documents who owes how much and when payment must be made.

T bond

A bond with a 30-year maturity that pays interest every 6 months.

T-Note

A bond with a 2-10 year maturity that pays interest every 6 months.

T-bill

A short-term bond that can mature in 2 days to 26 weeks, paid out only at maturity.

Zero coupon bond

A bond that pays interest only at maturity.

Owner equity formula

Assets minus debt (E=V-D).

Leverage ratio

The ratio of debt to equity (D/E).

Insolvency definition

When a firm's liabilities/debts are greater than its assets.

Passive investing

Investment strategy involving picking stocks that mimic a broad market index.

Active investing

Investment strategy involving picking individual stocks to 'beat the market'.

Diversification

A risk management strategy that includes a wide variety of investments within a portfolio.

Efficient market hypothesis

Prices of traded goods reflect all publicly available information.

Downside of diversification

There is no downside; it reduces risk without reducing expected return.

Consumer Price Index (CPI)

A basket of goods and services bought by a typical consumer.

Producer Price Index (PPI)

Average price received by producers for intermediate and final goods.

CPI formula

Price of good * weight %.

Real price equation

(CPI base year / CPI now) x Nominal Price.

Real rate of return

Nominal rate of return minus the inflation rate.

Effect of actual inflation exceeding expected inflation

Harms lender.

Effect of actual inflation being less than expected

Harms borrower.

Expectation of inflation impacts

Lenders will increase nominal rates of interest.

Fisher Effect

The tendency of nominal interest rates to rise with higher expected inflation rates.

Actual rate of return formula

(Expected inflation - actual inflation) + equilibrium interest rate.

Aggregate demand

All combinations of inflation and output growth consistent with a specified level of spending growth.

Short-run aggregate supply

All combinations of inflation and output growth consistent with specified inflation expectations.

Long-run aggregate supply

Natural output growth rate; dependent on labor and capital quality/quantity.

AS/AD equilibrium

AD (m+v) = Solow growth curve.

Impact of increased spending growth on AD

AD shifts right, with actual and expected inflation differing.

Temporary shock to AS/AD model outcome

Effect of shock reverses before expectations adjust.

Change in money supply with 10% reserve requirement and Fed printing $100

Increase of $1000.

Monetary base components

Total reserves.

Effect of decreased demand for Treasury bonds

Interest rate increases.

Fed strategy to increase money supply

Buy bonds.

Impact of 50% reserve ratio and $100 million increased deposits

Money supply increases by $200 million.

Fractional reserve banking definition

Banks hold only a fraction of deposits on reserve.

Deflation condition according to the quantity theory of money

When money supply and velocity grow more slowly than real GDP.

Asset-backed securities creation process

Securitization.

M2 but not M1

Savings deposits.

Example of a real shock

Discovery and exploration of new oil deposits.

Expectation of inflation increase effect

Shifts the SRAS curve upward (to the left).

Deflation definition

When the price level falls and becomes negative.

Insecure property rights outcome

Leads to a decrease in the supply of savings.

Beneficiary of surprise inflation

Borrowers benefit when actual interest rates are lower than expected.

Required nominal interest rate for lender expecting 3% real return with 8% CPI

Must charge 11% nominal interest.

Effect of real shock in AS-AD model

A shock to the potential growth rate.

Implied growth in money supply given CPI increase

5%.

Best investment strategy between NY and London bonds

Sell in NY and buy in London.

Effect on US inflation rate of increased money growth rate by Fed

Increases in the short run; increases even more in the long run.

Impact of increased patience on equilibrium interest rate

Equilibrium interest rate would decrease.

Expected outcome of doubling money supply

Price level would double.

Effect of US government bond sales on interest rates and loanable funds

Interest rate goes up, quantity of loanable funds goes down.

Difference between deflation and disinflation

Deflation is negative inflation rates; disinflation is lower inflation rates than before.