Makro chapter 1-7

What should we ask ourselves when using an economic model?

The key relationships and assumptions in the model, how well it simplifies real-world economic behavior, and the limitations and potential biases of the model.

What are endogenous variables?

Variables determined within the model, such as production and consumption.

What are exogenous variables?

Variables that are set outside the model and taken as given, like government spending.

What is nominal GDP?

It measures output using current prices.

What is real GDP?

It adjusts nominal GDP for inflation, measuring output using constant prices.

What does the Consumer Price Index (CPI) measure?

It tracks the average change in prices paid by consumers.

What is the GDP Deflator?

It measures price changes for all goods and services included in GDP.

What is the Producer Price Index (PPI)?

It measures price changes from the perspective of producers.

What is GDP per capita?

Economic output per person, not accounting for cost-of-living differences.

What is PPP-adjusted GDP per capita?

GDP per capita that accounts for differences in price levels across countries, reflecting purchasing power.

What are the properties of a production function?

Properties include diminishing returns, constant returns to scale, and substitutability of inputs.

Why is the Cobb-Douglas production function significant?

It reflects real-world properties like constant returns to scale and diminishing marginal productivity of inputs.

What does the demand for a product depend on in monopolistic competition?

Price elasticity, consumer preferences, and competitors’ pricing strategies.

How is the price elasticity of demand computed?

Using a specific formula that considers the percentage change in quantity demanded over the percentage change in price.

How do firms maximize profits?

By setting marginal cost equal to marginal revenue and choosing optimal input levels.

What is the relationship between price elasticity and price mark-up?

Higher elasticity leads to a lower mark-up.

What determines the price level?

Production costs, mark-ups, and market conditions.

How is the natural level of production determined?

By the intersection of aggregate supply and aggregate demand at full employment.

What is the nominal interest rate?

The observed rate without adjusting for inflation.

What is the real interest rate?

The nominal rate adjusted for inflation.

What could cause nominal interest rates to be negative?

Policies like quantitative easing or high demand for secure assets.

Why is investment important?

It drives capital accumulation, economic growth, and future production capacity.

How is the desired level of capital stock found?

By equating the marginal product of capital to the real interest rate.

What affects the level of investment in the long-run?

Optimal capital stock.

What affects the level of investment in the short-run?

Expectations, economic shocks, and current profitability.

Why is investment more volatile than output?

It reacts strongly to changes in interest rates, business confidence, and external shocks.

What are durable goods?

Long-lasting goods like cars, sensitive to economic cycles.

What is the liquidity constraint?

A limit on borrowing that increases the marginal propensity to consume.

What is the definition of the natural rate of interest?

The interest rate at which output equals its potential level without causing inflation.

What is the law of motion for capital per effective worker?

K* = sY - δK, where K is the capital per effective worker, s is the savings rate, Y is output, δ is depreciation.

What happens to capital per effective worker in steady state?

It remains constant.

What is absolute convergence?

The idea that all economies converge to the same steady state.

What is conditional convergence?

Economies converge accounting for differing fundamentals.

What is the Golden Rule in economics?

The savings rate that maximizes steady-state consumption per worker.

What determines the natural rate of unemployment?

Job matching efficiency, labor market frictions, and institutional arrangements.

How do wage-setting and price-setting curves interact?

Their intersection determines the equilibrium wage and price.

What is hysteresis in unemployment?

When temporary increases in unemployment lead to a permanently higher natural rate.

What determines the long-run rate of inflation?

The growth rate of money supply relative to the growth of output.

What is the Quantity Theory of Money?

An equation M * V = P * Y that connects money supply (M) and price level (P) to output (Y) and velocity (V).

What are the costs of inflation?

Including shoe-leather costs, menu costs, tax distortions, and uncertainty affecting savings and investment.

What is seigniorage?

Revenue earned through money creation, effectively a tax on holding money.