Macroeconomics: Exam 2

Loanable Funds Market

The market where savers supply funds for borrowers.

Interest Rate

The price of loanable funds.

Expected Returns

On a capital investment is the anticipated rate of return based on the probabilities of all possible outcomes.

Real Interest Rate

The interest rate corrected for inflation; the rate of return in terms of real purchasing power.

Nominal Interest Rate

The interest rate before it is corrected for inflation; it is the stated interest rate.

Fisher Equation

Real interest rate = nominal interest rate - inflation rate or nominal interest rate = real interest rate + inflation rate.

Equilibrium Interest Rate

The price of borrowing money determined by the interaction between savers and borrowers.

Income and Wealth

Increases in income and wealth generally produce increases in savings.

Time Preferences

Refers to the fact that people prefer to receive goods and services sooner rather than later.

Consumption Smoothing

Occurs when people borrow and save to smooth consumption throughout their lifetime.

Dissaving

Occurs when people withdraw funds from their previously accumulated savings.

Capital Productivity

If capital becomes more productive, the demand for loanable funds will increase.

Investor Confidence

A measure of what firms expect for future economic activity.

Government Borrowing

Increases in government borrowing are reflected as increases in the demand for loanable funds.

Equilibrium

Occurs at the interest rate where the plans of savers match the plans of borrowers.

Aggregate-Demand Aggregate-Supply Model

A model that economists use to study business cycles (short-run fluctuations in the economy).

Wealth Effect

The change in the quantity of AD that results from wealth changes due to price level changes.

International Trade Effect

Occurs when a change in the price level leads to a change in the quantity of net exports demanded.

Interest Rate Effect

Occurs when a change in the price level leads to a change in interest rates and therefore in the quantity of AD.

AD Curve

The curve that represents the total demand for final goods and services in an economy.

GDP Components

Consumption, investment, government spending, and net exports.

Decrease in Consumer Confidence

Leads to a leftward shift in the AD curve by reducing consumption.

Crowding Out

A phenomenon where increased government borrowing leads to higher equilibrium interest rates.

Aggregate Demand (AD)

Total demand for goods and services in the economy.

Aggregate Supply (AS)

Total supply of final goods and services in an economy.

Long Run Aggregate Supply (LRAS)

A vertical line at Y*, which is the full employment output.

Short Run Aggregate Supply (SRAS)

Indicates a positive relationship between the price level and real output supplied.

Long Run

A period of time sufficient for all prices to adjust.

Short Run

A period of time in which some prices change but others take more time.

Shifts in Consumption

Factors include National Wealth, Expected future incomes, and Taxes.

Shifts in Investment

Factors include Firm Confidence, Interest Rates, and Quantity of Money Supply.

Shifts in Net Exports

Factors include Foreign Income and Value of the Dollar.

Input Prices

Examples include worker's wages, which do not adjust quickly.

Menu Costs

The extra costs associated with changing prices.

Money Illusion

Occurs when people interpret nominal values as real values.

Supply Shocks

Surprise events that change firms' production costs.

Recession

An economic downturn characterized by declines in real GDP growth and increases in the unemployment rate.

Great Depression

The single biggest economic contraction the US has ever experienced.

Fiscal Policy

Use of government's budget tools - government spending and taxes - to influence the macroeconomy.

Monetary Policy

Involves adjusting the money supply to influence the economy.

Great Recession

Began in December 2007 and lasted 18 months, making it the longest recession in the US since WWII.

Dodd-Frank Act

The primary regulatory response to the financial turmoil that contributed to the Great Recession.

COVID Recession

The economy went into recession 7 weeks post the first diagnosis of the virus in the US.

Declines in Aggregate Demand

AD changes in response to many factors, leading to recessionary periods.

Declines in Aggregate Supply

Shifts in AS can also bring recessionary conditions.

Economic Growth

Illustrated in the AD-AS Model using the LRAS curve.

Negative Supply Shock

Occurs when a sudden increase in input costs causes the SRAS curve to shift leftward.

Positive Supply Shock

An unexpected event that increases production capacity.

AD-AS Model

Used to see how changes in either AD or AS affect real GDP, unemployment, and the price level.

Natural Rate of Unemployment (u*)

The unemployment rate at which the economy is at full employment.

Aggregate Demand Curve Shift

Indicates lower total spending at every price level.

Supply Shock

An unexpected, exogenous event that abruptly shifts SRAS.

Long-Run Aggregate Supply (LRAS)

The long-term output level of an economy that is not significantly impacted by short-term fluctuations.

Classical Economics

Stresses the importance of AS and believes the economy can adjust back to full employment equilibrium on its own.

Keynesian Economics

Stresses the importance of AD and believes the economy needs help returning to full employment equilibrium.

Aggregate Expenditures Model (AE Model)

A short-run model of economic fluctuations that holds that prices are completely sticky and that AD determines the economy's level of output and income.

Disposable Income

Income after taxes (Y-T).

Marginal Propensity to Consume (MPC)

The portion of additional income spent on consumption.

Marginal Propensity to Save (MPS)

The portion of additional income saved.

Aggregate Consumption Function

C = A + MPC(Y-T)

Investment

Private spending by firms on tools, plant, equipment, and inventory to produce future output.

Positive Unplanned Investment

Occurs when expected sales exceed actual sales, leading to an increase in inventory.

Aggregate Expenditures without Government Spending

AE = C + PI

Aggregate Expenditures with Government Spending

AE = C + PI + G + NX

Equilibrium in the AE Model

Represented by a series of points that comprise a 45-degree line.

Spending Multiplier

A number that tells us the total impact in spending from an initial change in a given amount.

Expansionary Fiscal Policy

Occurs when the government increases spending or decreases taxes to stimulate the economy towards equilibrium.

Contractionary Fiscal Policy

Occurs when the government decreases spending or increases taxes to slow economic expansion.

Countercyclical Fiscal Policy

Seeks to counteract business cycle fluctuations.

Time Lags in Fiscal Policy

Includes recognition lag, implementation lag, and impact lag.

Automatic Stabilizers

Government programs that automatically implement countercyclical fiscal policy in response to economic conditions.

Crowding-Out

Occurs when private spending falls in response to increases in government spending.

Supply-Side Fiscal Policy

Involves the use of government spending and taxes to affect the production side of the economy.

Marginal Income Tax Rates

Lowering marginal income tax rates can affect the supply side of the economy.

The Laffer Curve

An illustration of the relationship between tax rates and tax revenue.