UMD ECON201 (John Neri) Final Exam Review

GDP

the market value of final goods and services produced within a country in any given time period

Calculation of GDP

Consumption Expenditure + Investments + Government Expenditures + (Exports - Imports)

Y = C+I+G+(X-M)

Frictional unemployment

unemployment caused by natural labor market; people coming in and out of employment

Structural unemployment

unemployment caused by changes in market that make certain skills of laborers useless (technology) (skill set)

Cyclical unemployment

unemployment caused by the business cycle (recession)

Unemployment

part of the labor force that is not working

Characteristics of an unemployed person

- be actively seeking employment

- able to work

Formula for unemployment rate

(Unemployed/Labor Force) X 100

CPI (Consumer Price Index)

a measure of the average of the prices paid for a fixed basket of goods and services

Formula for CPI

(Cost of Basket At Current Year/Cost of Basket At Base Year) X 100

Inflation

sustained increase in overall prices

Formula for inflation rate

(CPI this year - CPI last year / CPI last year) X 100

Potential GDP

real GDP when all firms are operating at full employment

Forces driving growth in potential real GDP

- growth in supply of labor

- growth in labor productivity

Long-run aggregate supply curve

shows relationship between quantity of real GDP supplied and price level when real GDP equals potential GDP

Causes of LAS curve shifting right

- shifting right means real GDP is increasing

- physical capital stock, labor and/or technology increases

Crowding-out effect

a rise in interest rates and a resulting decrease in planned investment caused by the federal government's increased borrowing to finance budget deficits and refinance debt.

Nominal interest rate

number of dollars that a borrower pays and a lender receives in interest in a year expressed as a percentage of the number of dollars borrowed and lent (example 10%, if annual interest paid on $50 loan is $5)

Real interest rate

nominal interest rate adjusted to remove effects of inflation

Formula for real interest rate

nominal interest rate - inflation rate

Effects to lender and borrower when the inflation rate is higher than expected

Harms lenders, benefits borrowers

Effects to lender and borrower when the inflation rate is lower than expected

Benefits lenders, harms borrower

Functions of money

- medium of exchange

- unit of account (measure of stating prices of goods and services)

- store of value

How banks create money

fraction of deposit held in reserves; remainder can be loaned (excess reserves); quantity of money increases with a multiplier effect

Open market operations

the purchase and sale of U.S. government bonds by the Fed

Effects of open market operations

Increase or decrease in bank reserves and monetary base

Multiplier effect

the amplified change in equilibrium expenditure when autonomous expenditure changes

Autonomous expenditure

an expenditure that does not depend on the level of GDP (investments, government expenditure, exports)

Equilibrium expenditure

the level of aggregate expenditure that occurs when aggregate planned expenditure equals real GDP

Marginal propensity to save (MPS)

the fraction of the amount by which saving changes when disposable income changes

Marginal propensity to consume (MPC)

the fraction of any change in disposable income spent on consumer goods

Marginal propensity to import (MPM)

the fraction of an increase in real income (real GDP) spent on imports

Formula for MPC

MPC = 1 - MPS

Fiscal policy

use of federal budget to achieve macroeconomic objectives (full employment, economic growth, price stability, etc.)

Discretionary fiscal policy

fiscal policy that is the result of deliberate actions by policy makers rather than rules

Automatic fiscal policy

a fiscal policy action that is triggered by the state of the economy

Automatic stabilizers

changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policymakers having to take any deliberate action

Lags in discretionary fiscal policy

recognition (Information), law-making (implementation) and impact (response) lag

Lags in monetary policy

recognition and operational

Fed's dual mandate

price stability and maximum employment

Fed's preferred monetary policy instrument

federal funds rate

Federal funds rate (FFR)

the interest rate at which banks make overnight loans to one another

Why Fed increases FFR

- inflation rises above target or expected to rise (inflation gap)

- positive output gap

Why Fed decreases FFR

- inflation below target or expected to go below (recession gap)

- negative output gap

Formula for Taylor rule

FFR Target rate = 2% + INF + 0.5(INF - 2%) + 0.5(output gap)

Steps of expansionary monetary policy

Fed buys bonds; money supply increases and interest rates fall; C, I and (X-M) increase; real GDP and inflation rate (P) increase

Steps of contractionary monetary policy

Fed sells bonds; money supply decreases and interest rates rises; C, I and (X-M) decrease; real GDP and inflation rate (P) decrease

Short-run Phillips curve

relationship between inflation and unemployment when expected inflation rate and natural unemployment rate are held constant

Long-run Phillips curve

relationship between inflation and unemployment when actual inflation rate equals expected inflation rate

Keynesian economic theory

theory emphasizing government spending and deficits can help the economy deal with its ups and downs. Proponents of this theory advocate using the power of government to stimulate the economy when it is lagging.

Classical economic theory

The view that an economy will self-correct from periods of economic shock if left alone. AKA "laissez-faire"

Monetarist economic theory

theory that the amount of money in the system is the major determinant of price levels (i.e. use of monetary policy)

Equation for quantity of money theory

M x V = P x Y

Equation for quantity of money theory, in terms of growth rate

ΔM/M + ΔV/V = ΔP/P + ΔY/Y

Formula for the government expenditure multiplier

1 / 1 - [MPC(1 - tax rate) - MPM]

Formula for the autonomous tax multiplier

- MPC/1 - [MPC(1 - tax rate) - MPM]

Reason why SRAS shifts upwards

the quantity supplied increases when the price rises

Reasons why AD slopes downwards

the price level drops, the quantity of output demanded increases

- wealth effect

- interest-rate effect

- exchange-rate effect

Cost-push inflation

when prices rise due to an increase in the cost of production.

Demand-pull inflation

increases in the price level (inflation) resulting from an excess of demand over output at the existing price level, caused by an increase in aggregate demand

Stagflation

a period of slow economic growth and high unemployment (real GDP decreases) while prices rise