Macro Term Test (ECO105)

Fallacy of Composition (And Eco E.g.)

What is true for one is not true for all (If one farmer increases Q.S., they make more money. If all farmers increase Q.S., Price falls and they will not.)

Paradox of Thrift (Why does it occur)

Increased savings by individuals cause total savings to fall due to falling employment/income. (Consumer spending \= Business income, Business spending \= Consumer income)

The Fundamental Macroeconomic Question.

Yes (who supports and what causes business cycles)

No (who supports and what causes business cycles)

If left alone, do markets quickly self adjust?

Yes (Smith, Say, Hayek): extra-economical events and government policy cause most economic problems.

No (Keynes): Most economic problems are consequences/byproducts of normal market.

Say's Law (explain)

supply creates its own demand (e.g. supplied inputs increase income and create demand for output)

What do all macro-economists agree on? (3)

There is some role for governments (property rights), business cycles happen even without government failure, markets eventually adjust.

What Macroeconomic choices to consumers make?

Spend vs Save, Buy Domestic vs Foreign

What Macroeconomic choices to Businesses make?

Investment spending, hiring labour, domestic vs foreign inputs/sales.

What Macroeconomic choices do governments make?

Fiscal Policy (spending, taxes and transfers)

What Macroeconomic Choices do Banks make?

Loans and Monetary Policy (Control the supply of money, control interest rates)

What Macroeconomic choices does the R.O.W. make?

Import/Export to/from Canada, Invest in/get investment from Canada (Impacted by value of $CAD)

Nominal GDP

Value at current prices of all final products/services produced annually in a country

What is a final product? What is an intermediate product?

Final products are consumed directly by the consumer, whereas input purchases are intermediate products.

Real GDP. Why is it useful?

Value at constant prices of all final products/services produced annually in a country. (P held constant at chosen year, where RGDP\=NGDP). It allows us to asses changes in the quantity of goods, unimpacted by inflation.

Value Added (prevents what)

Value of outputs minus the value of intermediate products/services, equal to the value of the final product/service, equal to the incomes of all input owners. (Prevents double counting)

What is the macroeconomic "mantra"

Aggregate Spending, C+I+G+X-M \= Y, Aggregte Income.

What is net exports and why do we use it when calculating Y?

X-IM, because IM spending is counted in other spending categories (C, I, G).

Disposable income = ______

Aggregate income (Y) - Net Taxes (T)

Potential GDP

Real GDP when all inputs are fully employed (in normal times)

Economic Growth is an __________ due to an __________.

Expansion in an economy's capacity to produce (an increase in PGDP per Capita) due to an increase in the quantity or quality of inputs.

Rule of 70

Doubling time (in years) \= 70/(percentage growth rate).

Productivity = ___, and is _______.

RGDP produced by 1 hour of labour, it is the key source of increased standards of living (work time per purchase)

Business Cycles

ups/downs of general economic activity, measured by fluctuations of RGDP around PGDP

In an expansion RGDP __________ to a _________ and in a contraction RGDP ________ to a _______. What is a recession?

In an expansion RGDP rises to a peak, in a contraction RGDP falls to a trough. A recession is 2+ successive quarters of contraction.

Output gaps= ________.

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What are the types and why do they occur?

RGDP-PGDP. Recessionary gaps are negative due to unemployed inputs, Inflationary gaps are positive due to people working overtime or unemployment falling below the natural rate.

RGDP per capita is the best measure of quality of life, but what does it miss?

It misses Non-market (like domestic/volunteer) production, Underground Economy (~5-15% CAN GDP), Environmental Damage (negative externalities or less future resources), Leisure, Political Freedom and Social Justice.

Unemployed

No paid work and actively seeking a job (otherwise not in the labour force), including temporary lay-offs and about to start.

Labour Underutilization rate

unemployment rate including unemployed, involuntary part-time workers, and discouraged workers

Frictional Unemployment

Due to normal labour turnover and job search (healthy)

Structural Unemployment

Due to technological change or international competition making workers' skills obsolete (healthy, but retraining needed)

Seasonal Unemployment

due to seasonal/weather changes (healthy)

Cyclical Unemployment

due to fluctuations in economic activity over business cycles (unhealthy)

Full Employment

Natural rate of unemployment, RGDP\=PGDP, No cyclical Unemployment. Can be exceeded when frictional, structural, and/or seasonal unemployment reduce during inflationary gap.

Inflation (BoC target), Core inflation rate

A persistent rise in average price level and fall in the value of money, measured by CPI. BoC targets 1-3%. Core rate excludes volatile categories in CPI.

Why worry about inflation?

Rising prices and falling value of money is bad for fixed income and savings

Real interest rate (\=Nominal interest rate- inflation rate) adjusts nominal (observed) to remove inflation which lowers real returns

Unpredictable prices create risk and discourage business investment/planning

How are expectations of inflation self-fulfilling?

Expecting inflation, workers demand a raise, businesses raise prices to cover these (and expected) increased input costs, and banks raise the nominal interest rate on loans to protect returns which increases cost of paying them back.

What is deflation and why worry?

Persistent fall in average price level and rise in the value of money.

Encourages saving and stunts spending, therefore lowering wages, increasing unemployment and shrinking GDP. Lower incomes/revenues make it harder to pay back loans (paid back in more valuable $). Asset prices fall and mortgage values may overtake home values.

Why spend money when you can get more with it later, why take out loans/invest when you pay back in more valuable money?

Quantity of Money Theory (and explanation)

(MxV\=PxQ), increase in M causes equal percentage increase in P, V and Q assumed to be fixed. With higher income but fixed quantity, buyers compete to raise prices.

Phillips Curve

A graph showing the inverse relationship between unemployment and inflation

What is Demand-Pull inflation and what is it consistent with?

Rising average P level caused by increase in demand (because of shortages). Alternatively, contraction lowers incomes and therefore Demand, creating surplus and lowering P.

Consistent with Phillips curve (Inverse relationship of Unemployment and Inflation/GDP)

Supply Shocks (e.g.)

events directly affecting businesses' costs, prices, and supply (e.g. input cost increase, natural disasters destroying supply)

Cost-Push Inflation.

What does it create?

Rising average P level caused by a decrease in supply (caused by increasing costs). There is also an accompanying increase in M.

Creates stagflation, where inflation and unemployment both rise and RGDP decreases.

Long-Run Aggregate Supply

Vertical Line at PGDP on graph of CPI (Y) and RGDP (X), prices and wages have adjusted so invisible hand works

Short Run Aggregate Supply. What is this like in micro who is most important?

Quantity of RGDP Macro players plan to supply at different price levels (like micro Q.S.). Businesses are most important.

Law of Short Run Aggregate Supply

as the price level rises, aggregate quantity supplied of real GDP increases (because with fixed input prices, higher output prices mean higher profits)

In the short run, do input prices change?

No, some do not. Long-run equilibrium is reached when all inputs have adjusted.

Increase in Aggregate Supply. Like what in Micro?

What shifts and in which direction? How does their intersection change?

Increase in an economy's capacity to produce RGDP because quality or quantity of inputs has increased. Like increase in supply in micro.

SAS, LAS, and PPF shift right. We assume that the LAS and SAS intersect at a lower price level due to cost reductions.

How do changing input prices shift LAS and SAS and why?

SAS shifts (left for increase, right for decrease) due to changing profits, but LAS remains constant.

A leftward shift of SAS due to, for example, rising input prices, natural disasters, and/or depreciating inputs/equipment represents a \____________

Negative Supply Shock

A rightward shift of SAS and LAS due to, for example, falling input prices, new ideas/resources/tech, or plans to increase quality/quantity of inputs represents \_________.

Positive Supply Shock

Aggregate Demand (what is it like in micro?)

Quantity of RGDP Macro Players (mostly consumers) plan to demand at different price levels. (Like Q.D. in Micro)

All plans are \______ run. There is no LAD because \___________.

short, AD target\= AS target

Law of Aggregate Demand. Why?

As price level rises, aggregate quantity demanded of RGDP decreased. Though there are no Canadian substitutes, but X and IM can change.

Describe Consumers' Aggregate Demand plans.

60% of A.Q.D. of Canadian RGDP. Is the most stable due to neccecity purchases. 4% of net income (after avg 22% net taxes) is saved, but the rest is usually spend on A.Q.D.

Describe Businesses' Aggregate Demand plans.

15-25% of A.Q.D. of Canadian RGDP. Is the most volatile due to postponement. New factories/equipment increase LAS and SAS (increase in inputs) but are also bought from others so increases AD.

Describe Government's Aggregate Demand plans.

Stable ~20%. yearly budget (minus transfer payments, which are included in C).

Describe the R.O.W.'s Aggregate Demand plans.

More than 1/3 of CAN A.Q.D. of Canadian RGDP is X for R.O.W., IM don't count for AD/RGDP, must subtract.

Demand Shocks.

What happens to SAS, why, and then to equilibrium?

Changes in any factor other than price level that shifts Aggregate Demand.

SAS0 is based on AD0, but AD1 occurs elsewhere, either:
a) to the right (positive) creating shortage, increasing P and AQD of RGDP, lowering Unemployment (inflationary gap)
b) to the left (negative) creating surplus, lowering P and AQD of RGDP, increasing Unemployment (recessionary gap)

What creates a positive demand shock (rightward shift of AD)?

Optimistic expectations
Lower Interest Rates
Lower Taxes/Increased Gov. spending
Increase in R.O.W. GDP
Lower Value of $CDN (X up, IM down)

What creates a negative demand shock (leftward shift of AD)?

Pessimistic Expectations
Higher Interest Rates
Higher Taxes/Lower Gov. spending
Decreasse in R.O.W. GDP
Higher value of $CDN (X down, IM up)

Short run macro equilibrium (with existing inputs)

Where SAS and AD intersect, with no tendency for change.

Long run macro equilibrium (with existing inputs).

What has happened?

SAS and AD also intersect with LAS, RDGP\=PGDP.

Input prices have adjusted so that all inputs are fully employed. Price level is stable, Say's law has held, plans came true.

Market for loanable funds

Banks Coordinate the supply of loanable funds (savings) with demand for loanable funds (borrowing). Same as classic D/S curves, but the price is interest rate.

How can banks save Say's Law?

By coordinating the supply and demand of/for loanable funds, savings can still create spending (through investment sending). I replaces the missing C, and aggregate spending \= aggregate income once more. Bonus: Increased inputs due to I increase RGDP.

What happens in a negative supply shock?

Stagflation, leftward shift of SAS, constant LAS, shortages raise P level and lower Aggregate Q.S. and increasing unemployment.

What happens in a positive supply shock?

SAS and LAS both shift right, new intersection is down to the right (P down Q.S. RDGP up), unemployment down. Still in long-run equilibrium, but PGDP has increased.