Econ test 2

Animal spirits

What determines the autonomous level of business investment according to John Maynard Keynes

Bracket Creep

A tax problem of the late 1970s

Stagflation

High inflation coupled with high unemployment

Money Illusion

A Keynesian notion in which workers are fooled by rising nominal wages while real wages actually fall

Twin Deficits Anomaly

Government spending>taxes = Imports>exports

C=f(yd)

Consumption is a function of disposable income

Labor force (L)

Employed and unemployed E+U

Individuals aged 16-66 who are not institutionalized and actively seeking employment

Unemployment rate

U/L Unemployed / Labor force

Cyclical Unemployment

Bad, unemployment due to changes in the business cycle

Frictional Unemployment

Unemployment due to job switching

Structural Unemployment

Unemployment due to changes in the overall composition of the economy (technology)

Seasonal Unemployment

Unemployment due to change of season based jobs

Full employment

Natural rate of unemployment (U^N). Frictional + Structural. When there is NO cyclical unemployment

Leading economic indicator

What will happen

Lagging economic indicator

What has happened

Coincident economic indicator

What is happening right now

Underemployed

Overqualified for one’s current position (masters degree working as a trash guy)

Business Cycle

changes in the overall measure of economic activity over time

Peak —> Trough

Contraction/depression/recession

Trough —> Peak

Expansion

Trough —> Previous peak height

Recovery

Classical View

The economy is inherently stable. Government intervention tends to destabilize the economy.

Favors governmental deregulation

Keynes View

The economy is inherently unstable. Government intervention tends to stabilize the economy.

Favors government intervention like creating jobs

C=f(y^d)

Consumption is a function of disposable income

Positive relationship

I=f(r )

Investment is a function of real interest rate

Inverse relationship

Nx=f(e)(x-m)

Net exports are a function of exchange rate

Inverse relationship

Y1

U>U^N, Recessionary Gap, Industry up

Y2

U<U^n, Inflationary gap, Industry down

Y*

U=U^N, natural rate of unemployment, frictional and structural, no cyclical

AES

1)Consumption (brings up)

2)Investment (brings up)

3)Government Spending (brings up)

4)Taxes (brings down)

Autonomous consumption

Y intercept, level of consumption that takes place when income is 0

Y=AE

45º Line, 1 to 1

Relationship between MPC and MPS

MPC+MPS=1

Income (Y)

C+S Consumption plus Savings

Savings

Y-C Income minus Consumption

MPC Definition

Marginal propensity to consume, change in consumption that takes place with one more $ of income.

MPS Definition

Marginal Propensity to spend, change in spending tha occurs with one more $ of income

Government Spending Multiplier

change in Y over change in G, or 1/1-MPC

Tax Multiplier

Change in Y over change in T, or -MPC/1-MPC

Leakage-Injections Stages

1) S=0

2) S=In

3)S=In+G

4)S+T=In+G

5)S+T+M=X+In+G

Income and Expenditures Stages

1) AE1=C

2)AE2=C+I

3)AE3=C+I+G

4)AE4=C(Y-T)+I+G

5)AE5=C(Y-T)+I+G+Nx

Keynesian Conjecture 1

Consumption is a function of disposable income

Keynesian Conjecture 2

The marginal propensity to consume is some number between 0 ≤ MPC ≤ 1

Keynesian Conjecture 3

As income rises, APC falls. APC=C/Y

Relationship between APC and APS

APC+APS=1 APC=C/Y APS=S/Y

As Y(income) rises, APC falls

Short run relationship between APC and Y

As Y(income) rises, APC levels out/remains constant

Long run relationship between APC and Y

Crowding out

Government spending gets too big and eliminates private investment

The change in income Y is the same as the change in Government Spending G and the change in taxes T.

Conditions:

1)if there is no crowding out

2) if the government spending multiplier equals the tax multiplier

Balanced budget

G=T When government spending is equal to taxes

G>T

Budget deficit

G<T

Budget surplus

1)GDP

=Depreciation+Indirect business taxes+rent+wages+interest+profit

2)NDP/Net Domestic Product (GDP-Depreciation)

=Indirect business taxes+rent+wages+interest+profit

3)National Income (GDP-Depreciation-Indirect business taxes)

=Rent+wages+interest+profit

4) Personal income

National income+government transfer payments-Social security contributions-undistributed corporate profits

5) Disposable Income

Personal income-Personal taxes

Real Purchases Effect

Describes why the AD curve is (-)

EX when prices are 1/3 off consumption goes up as price goes down.

Interest Rate Effect

Describes why the AD curve is (-)

EX When the price of cars drops Investment goes up and interest rate goes down.

Net Exports Effect

Describes why the AD curve is (-)

EX When domestic goods are cheaper than foreign goods, exports increase and imports decrease, leading Net Exports to increase making price decrease. Output increases (Y)

Equation of Exchange

Describes why the AD curve is (-)

(M)(V)=(P)(Y)

Shift in AD

Increase in change in C,I,G,T,NX,V,M

When increased, all shift the AD curve right except Taxes, which when increased, shift the curve left

Keynesian View/Section of AS

Low levels of output

Short Run

Output is change, price level is held constant (Sticky Prices)

Where Fiscal Policy is most effective

Helps describe why the AS curve is (+)

Classical view/Section of AS

High levels of output

Long run

Output is constant, price level varies (fixed output over time)

Where fiscal policy is the most Ineffective

Helps describe why the AS curve is (+)

Compromise Section of AS

Where Fiscal policy is moderately effective

Helps describe why the AS curve is (+)

Aggregate Supply Curve

Fiscal Policy

Change in G and/or Change in T

Expansionary Fiscal Policy

Positive change in G and/or Negative change in T

Contractionary Fiscal Policy

Negative change in G and/or Positive change in T

Monetary Policy

Change in M^s

Inflation formula

π=π^e -B(U-U^N) + ε