ECON201 Final Exam

Aggregate Expenditure (AE)

Total spending in the economy: the sum of consumption, planned investment, government purchases, and net exports (AE = C + I + G + NX).

Aggregate Expenditure Model

A macroeconomic model focusing on the short-run relationship between total spending and real GDP, assuming the price level is constant.

Macroeconomic Equilibrium (AE Model)

Occurs when planned aggregate expenditure (AE) equals real GDP (Y), i.e., AE = Y.

Planned Investment

Spending firms plan on capital goods and households plan on new homes; excludes unplanned changes in inventories.

Actual Investment

Planned investment plus unplanned changes in inventories; what the BEA actually measures.

Consumption Function

The relationship between consumption spending and disposable income, graphed as an upward-sloping line.

Marginal Propensity to Consume (MPC)

The fraction of an extra dollar of disposable income that is spent on consumption; the slope of the consumption function.

Marginal Propensity to Save (MPS)

The fraction of an extra dollar of disposable income that is saved; MPC + MPS = 1.

Current Disposable Income

Personal income minus personal income taxes plus government transfer payments.

Consumption-Smoothing

The tendency of households to keep consumption stable over time despite fluctuations in income.

Determinants of Consumption

Current disposable income, household wealth, expected future income, price level, and interest rate.

Determinants of Planned Investment

Expectations of future profitability, interest rates, taxes, and cash flow.

Net Exports (NX)

The value of exports minus the value of imports.

Potential GDP

The maximum output an economy can produce given full employment of labor, capital, technology, and institutions.

Recessionary Gap

When equilibrium real GDP is below potential GDP; solved by shifting AE up via tax cuts or increased spending.

Expansionary (Inflationary) Gap

When equilibrium real GDP is above potential GDP; solved by shifting AE down via tax increases or spending cuts.

Multiplier Effect

A small change in autonomous spending causes a larger change in equilibrium real GDP.

Multiplier Formula

Multiplier = 1 / (1 - MPC).

Autonomous Expenditure

Spending (like planned investment, government purchases, net exports) that does not depend on the level of GDP.

Fiscal Policy

Changes in federal taxes and government purchases intended to achieve macroeconomic goals like price stability, employment, and growth.

Automatic Stabilizers

Government spending and taxes that automatically rise or fall with the business cycle without new legislation (e.g., unemployment insurance).

Discretionary Fiscal Policy

Intentional government actions, such as new laws, that change spending or tax levels to influence economic activity.

Expansionary Fiscal Policy

Increasing government purchases or decreasing taxes to shift AD right and close a recessionary gap.

Contractionary Fiscal Policy

Decreasing government purchases or increasing taxes to shift AD left and close an inflationary gap.

Legislative Lag

The time it takes Congress to pass a fiscal policy bill.

Implementation Lag

The time it takes to start a government spending project after it has been approved.

Crowding Out

A decline in private spending caused by increased government purchases raising interest rates.

Budget Deficit

When the government spends more than it collects in taxes in a given year.

Budget Surplus

When the government collects more in taxes than it spends in a given year.

Balanced Budget

When government spending equals tax revenue.

National Debt

The total amount the government has borrowed over time (accumulated deficits).

Supply-Side Economics

Fiscal policies intended to affect long-run aggregate supply (potential GDP), often by changing tax incentives to work, save, and invest.

Tax Wedge

The difference between the pretax wage paid by firms and the post-tax wage received by workers.

Progressive Tax

A tax system where tax rates increase as income increases (e.g., U.S. individual income tax).

Money

Any asset people are generally willing to accept in exchange for goods, services, or debt payment.

Barter

Trading goods and services directly for other goods and services without money.

Double Coincidence of Wants

A situation where two people each have exactly what the other wants, required for barter to work.

Commodity Money

Money that has intrinsic value/use independent of its function as money, like gold or animal skins.

Fiat Money

Money with no intrinsic value that is declared legal tender by a government, like U.S. paper currency.

Functions of Money

Medium of exchange, store of value, unit of account, and standard of deferred payment.

M1 Money Supply

Currency in circulation plus checking account deposits (and traveler's checks).

M2 Money Supply

M1 plus savings accounts, small time deposits, money market accounts, and money market fund shares.

Financial Intermediary

An institution, like a bank, that stands between savers who deposit money and borrowers who receive loans.

Reserves

Deposits a bank keeps as cash in its vault or on deposit with the Federal Reserve.

Required Reserve Ratio

The minimum fraction of deposits banks are legally required to hold as reserves.

Excess Reserves

Reserves banks hold above the legally required amount.

Fractional Reserve Banking

A system where banks keep less than 100% of deposits as reserves.

Bank Run

A situation where many depositors simultaneously withdraw money from a bank.

Bank Panic

A situation where many banks experience bank runs at the same time.

Money Multiplier

1 divided by the required reserve ratio; shows how much an initial deposit can expand the money supply through lending.

Quantity Theory of Money

M x V = P x Y, where M is money supply, V is velocity, P is price level, and Y is real output.

Velocity of Money

The average number of times each dollar in the money supply is used to buy goods and services in a year.

Monetary Policy

Actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic goals.

Federal Reserve (the Fed)

The central bank of the United States, created in 1913, responsible for monetary policy.

Dual Mandate of the Fed

The Fed's two primary goals of price stability and high employment.

Open Market Operations

The Fed buying or selling U.S. Treasury securities to increase or decrease the money supply.

Discount Rate

The interest rate the Federal Reserve charges banks on discount loans.

Federal Funds Rate

The interest rate banks charge each other for overnight loans; the Fed's key policy target.

Expansionary Monetary Policy

The Fed decreasing interest rates (increasing money supply) to raise real GDP; also called loose or easy money policy.

Contractionary Monetary Policy

The Fed increasing interest rates (decreasing money supply) to reduce inflation; also called tight money policy.

Loanable Funds Model

A model concerned with the long-term real interest rate, relevant to long-term investors.

Money Market Model

A model concerned with the short-term nominal interest rate, relevant to Fed policy.

Say's Law

The classical economic idea that 'supply creates its own demand.'

Keynes' Law

The Keynesian idea that 'demand creates its own supply,' more accurate in the short run.

Aggregate Demand (AD) Curve

A downward-sloping curve showing the relationship between the price level and quantity of real GDP demanded.

Short-Run Aggregate Supply (SRAS) Curve

An upward-sloping curve showing the relationship in the short run between price level and quantity of real GDP supplied.

Long-Run Aggregate Supply (LRAS) Curve

A vertical curve at potential GDP, showing that in the long run output does not depend on price level.

Wealth Effect

Rising price levels reduce the real value of nominal wealth, lowering consumption; part of why AD slopes downward.

Interest-Rate Effect

Rising price levels increase money demand and interest rates, reducing investment; part of why AD slopes downward.

International-Trade Effect

Rising domestic price levels make exports pricier and imports cheaper, lowering net exports; part of why AD slopes downward.

Sticky Prices and Wages

Prices and wages that do not respond quickly to changes in demand or supply, explaining the upward-sloping SRAS.

Menu Costs

The costs firms face when changing prices, contributing to price stickiness.

Supply Shock

An unexpected event, such as an oil price spike, that shifts the SRAS curve.

Stagflation

A combination of inflation and recession, usually caused by a negative supply shock.

Long-Run Macroeconomic Equilibrium

Occurs where AD and SRAS intersect at the LRAS level (potential/full-employment GDP).

Scarcity

The basic economic problem that resources are limited while wants are unlimited.

Opportunity Cost

The value of the next best alternative given up when making a choice.

Law of Demand

As the price of a good rises, the quantity demanded falls, all else equal (and vice versa).

Law of Supply

As the price of a good rises, the quantity supplied rises, all else equal (and vice versa).

Market Equilibrium

The price and quantity at which quantity demanded equals quantity supplied.

Surplus (Economics)

A situation where quantity supplied exceeds quantity demanded at a given price, pushing price down.

Shortage (Economics)

A situation where quantity demanded exceeds quantity supplied at a given price, pushing price up.

Gross Domestic Product (GDP)

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

Inflation

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

Deflation

A sustained decrease in the general price level of goods and services in an economy.

Unemployment Rate

The percentage of the labor force that is jobless and actively seeking work.

Business Cycle

The recurring pattern of expansion and contraction in economic activity over time.

Recession

A significant decline in economic activity, typically marked by falling real GDP, lasting more than a few months.

Microeconomics

The study of individual households, firms, and markets, and how they make decisions.

Macroeconomics

The study of the economy as a whole, including topics like inflation, unemployment, and economic growth.

Factors of Production

The resources used to produce goods and services: land, labor, capital, and entrepreneurship.

Circular Flow Model

A simplified model showing how money, goods, and services flow between households, firms, and the government.