Macroeconomics Final Exam (Cumulative)

Core Econ Principles, Demand, Supply and Equilibrium, Gains from Trade, Measuring Economic Performance, Business Cycles, Fiscal Policy, Monetary Policy and Banking, IS-MP Model

Monetary Policy

The management of a nation’s money supply and interest rates by its central bank to control economic growth, inflation, and employment.

Fed Rule-of-Thumb

The Taylor rule, a formula developed by economist John Taylor to guide interest rate decisions by linking the federal funds rate to inflation and economic growth. Suggests that if inflation is above its target or if the economy is growing faster than its potential (a positive "output gap"), the Fed should raise rates.

Comovement

How different economic variables tend to move together— rising and falling in synch — because the parts of the economic are interconnected

Output Gap

The difference between an economy's actual output and its potential output, which is the maximum output it can produce when running at full capacity

Quantitative Easing

Involves purchasing long-term assets like government bonds and mortgage-backed securities to lower long-term yields and stimulate the economy.
Used when short-term interest rates are near zero

Okun’s Rule of Thumb

Quantifies the relationship between output and the unemployment rate, saying that for every percentage point that actual output is less than potential output, the unemployment rate will be around half a percentage point higher

Substitution Effect

When interest rates are lower, and ultimately the reward for saving your money is lower, households will substitute away from saving and towards current consumption when interest rates fall.

Demand-Pull Inflation

Arises when demand exceeds the economy’s productive capacity, pulling prices up

Supply Shock

An unexpected change in production costs that shifts the Phillips curve

Dual Mandate

The Fed’s responsibility to use monetary policy to promote maximum employment and price stability

Maximum Employment

The highest level of employment that an economy can sustain while maintaining low and stable inflation. The Fed’s policy decision is informed by its assessments of the shortfalls of employment from its maximum level.

Price Stability

A low and stable rate of inflation maintained over an extended period of time. The Fed seeks to achieve inflation that average 2% over time.

Interest on Reserve Balances (IORB)

Interest paid on funds that banks hold in their reserve balance accounts at a Federal Reserve Bank

Overnight Reverse Re-purchase Agreement (ON RRP) Facility

The Federal Reserve’s standing offer to a broad set of financial institutions to deposit funds at the Fed and earn interest

Discount Window

The Federal Reserve’s lending to banks (the ‘discount window’) at the discount rate

Open Market Operations

Buying and selling of government securities by the Federal Reserve

Production (value-added) method for calculating GDP

Sums the incremental contributions to output at each stage of production to avoid double-counting inputs.

Expenditure approach to calculating GDP

Measures GDP by adding up consumer spending, investment, government purchases,
and net exports.

Why do economists typically focus on real GDP?

Changes in real GDP capture variations in actual output rather than shifts in prices

How does the household earn its income in the circular flow model?

By supplying labor and other factors of production to firms in factor markets

Who is Thomas Malthus

Economist that predicted that real income would tend towards the subsistence level, because if income grew, people would have more children, eventually driving wages back down

Why can sustained economic growth lead to higher living standards over time?

Growth typically raises per capita income, which can improve access to goods and services

Which statement best characterizes the “natural rate” of unemployment?

The unemployment level driven primarily by long-term structural and frictional factors

During an economic contraction, which factor most commonly contributes to involuntary
unemployment?

Limited wage flexibility (downward rigid wages)

Decoupling

Growing real output without a corresponding rise in resource use or environmental impact

Nominal GDP

The value of all final goods and services produced in a country during a given period, measured at current market prices

Formula: (Price of good x in base year * quantity of good x in second year) + (price of good y in base year * quantity of good y in second year)

Real GDP

nominal GDP adjusted for inflation, measured
using prices from a base year

Formula: (price of good x in base year quantity of good x in base year) + (price of good y in base year * quantity of good y in base year)

What typically causes a country’s productivity curve to shift outward (from PC to PC1)?

Improvements in technology, more capital per worker, or better-trained workers

What does a shift outward (from PC to PC1) imply for output per worker?

Indicates higher output per worker at each level of labor input

Disinflation

A slower rate of price increases. Example:
inflation falls from 6% to 3%, but prices still rise

Deflation

An actual decline in the overall price level (e.g. a 1% CPI change over a year)

Downward Wage Rigidity

Wages don’t easily fall when labor demand drops

Why can downward wage rigidity make recessions worse by contributing to involuntary unemployment?

Firms cut payroll via layoffs instead of reducing pay, so unemployment rises more than if wages could adjust downward

Cyclical unemployment

Arises from downturns in the business cycle (recessions).

Catch-up Growth

Poorer nations can quickly improve by
implementing technology and methods already used in richer nations

How does cyclical unemployment differ from frictional and structural unemployment?

Specifically tied to insufficient demand in the economy while frictional involves normal job switch and structural involves a mismatch of worker skills or location with available jobs.

Natural rate of unemployment

The long-run unemployment level from frictional (job search) plus structural (skill/location mismatch)

Which types of unemployment remain even when the economy is at its “full employment” level?

Absent cyclical downturn persist even in a healthy economy

List one policy that promotes long-run economic growth and one that could hinder it

Promote: Investing in public education, infrastructure, R&D, immigration, or open trade
Hinder: Heavy trade barriers, underfunding human capital, or persistent political instability reducing investment

Core Inflation

Removes volatile items—often food and energy—to reveal the underlying price trend

Commodity Money

Has some intrinsic value: gold, silver, copper, barley, salt, spices

Fiat Money

Paper money whose value is derived from government decree or fiat

Inflation

The pace at which prices in general are increasing over time

Gross Domestic Product (GDP)

Market value of the final goods and services produced within a country's borders during a specific time period

How do you calculate GDP from a production approach?

The sum of each firm’s value-added addition to the final product

Industries sales revenue - purchases of intermediate products used in production = #

# + taxes on products - subsidies to get to market prices = GDP

How do you calculate GDP from an expenditure approach?

Add up consumption, private investment, government spending, and exports to get aggregate demand. Equal to aggregate supply: domestic supply (y) + imports and solve for y. 

y = c + i + g + (x - m)

What does GDP NOT measure?

Capital depreciation (wear & tear), home production, underground activity, leisure, income inequality, externalities/spillovers, happiness

Gross National Product

Market value of everything produced by nationals of a country, even if production occurred when worker was temporarily abroad

What is the primary characteristic of a recession?

Unemployment aka negative output gap indicating economic slowdown

Malthusian Cycle

As economy grow, people have more kids --> more population leads to less resources --> famine and death

Who is considered apart of the labor force?

Anyone of working age (16+) that is currently looking for a job (in the last 4 weeks) and not in the armed forces or institutionalized

Discouraged Workers 

Workers who have given up looking for a job entirely

When does the unemployment rate typically peak?

Near the end of a recession

Quantity Theory of Money

MV (all money * velocity, how quickly it moves), aka Nominal GDP = PY (prices * real GDP)

How can fiscal policy be implemented?

Increasing government spending to keep taxes the same or lowering taxes but keeping spending the same, both resulting in more government borrowing

What is expansionary fiscal policy and what does it ultimately do?

More government borrowing that results in national debt

How does fiscal policy affect labor demand?

In both lowering spending and increases taxes or lowering taxes and increasing spending, it leads to more jobs

Government Expenditure Multiplier

Policy used to determine how an increased government spending in excess of taxes is going to affect the economy

Automatic Stabilizers

Policies that kick in automatically if the economy is going into a recession. (unemployment goes up, government checks go out with unemployment insurance)

What is the Federal Reserve trying to do?

Control the money supply; raising and lowering interest rates, controlling lending behavior, and making sure banks aren’t making risks to harm us (holding all the reserves at the banks, bank hold excess cash at the Fed)

What is the impact of changing the federal funds rate?

When they raise interest rates, we borrow less and invest less. When they lower interest rates, we borrow more and invest more.

What does the MP curve measure?

The real interest rate set by monetary policy and financial markets

What does the IS curve measure?

The output gap associated with each real interest rate

What is scarcity in the context of economics?

We have the desire to consume more resources than we have so we must make optimal choices on how to allocate them

Opportunity Cost Principle

The value of the best alternative you give up when making a choice; the benefits lost from the option not chosen due to scarcity

Marginal Benefit

The benefit associated with consuming one more unit. Found by taking the difference in total benefit from the additional unit to unit before

Macroeconomics

The study of the economy at large; economy-wide phenomena like economic growth, inflation and unemployment

Competitive Equilibrium Price

The price in a perfectly competitive market where quantity demanded and quantity supplied are the same

Law of Demand

As a product’s price does up the total quantity demanded by consumers will go down

Law of Supply

As the price of goods and services increases, the quantity suppliers are willing to produce and sell also increases, assuming all other factors stay the same

Market Supply Curve

The sum of the individual supply curves of all the potential sellers

What shifts the supply curve left?

A decrease in supply, decreasing the quantity supplied at each and ever price

What shift the supply curve right?

An increase in the supply, increasing the quantity supplied at each and every price

What is the relationship between the supply curve and marginal cost?

Your supply curve is your marginal cost curve because it plots the price associated with each specific quantity of gas you might supply

What six factors shift the market demand curve?

Income, Preferences, Prices of related goods, Expectations, Congestion and network effects, The type and number of buyers

What factor does NOT shift the demand curve?

A change in price

What does a shift left in market demand do?

Lowers the equilibrium price

What does a shift right in market demand do?

Increases the equilibrium price

Inferior Goods

Goods for which demand decreases as income increases. examples: bus rides, manual toothbrushes, single ply toilet paper

Normal Goods

Goods for which demand for a good or service increases when your income is higher. examples: housing, clothes, entertainment

Complementary Goods

When the higher price of one good decreases your demand for another good or the lower price of one good increases your demand for another good. example: cheaper gas leads more people to drive, increasing the demand of cars

Substitute Goods

Goods that replace each other. example: walking, cycling, ride-sharing, and catching the bus are all substitutes for driving

Network Effect

Where a product or service becomes more useful to you as more people use it

What does an increase in number of buyer in a market do to the market demand curve?

It shifts right

How do you calculate market demand from individual demand schedules?

Horizontally sum the quantities demanded by all consumers at each specific price point to get the total market quantity for that price, then repeat for all prices to build the market demand schedule

What happens when there are more buyers than suppliers in a market?

Prices will be raised

What do suppliers do if there is a excess supply?

Lower the prices

What do suppliers do if there is a shortage in supply?

Raise the prices

What five factors cause the supply curve to shift?

Raw material price increase, technology advances that make it cheaper to make a good, the number of sellers increasing, seller expectation of future prices, changes in prices of substitutes in production

What is a Production Possibilities Curve (PPC)?

The boundary between those combinations of goods and services that can be produced and those that cannot.

Through trade we get gains from trade, and through combining skills you gain more from the market

How do you find opportunity cost through a PPC?

OC = change in good y/ change in good x

How do you know if you have comparative advantage in an activity from a PPC?

If you can perform the activity at a lower opportunity cost than anyone else

GDP Deflator Formula

Nominal GDP/Real GDP * 100

GDP per capita

A country’s total economic output divided by its population

Peak

A high point in economic activity, begins the business cycle

Trough

A low point in economic activity, comes at the end of a recession

Recession

The period during which economic activity declines between a peak and a trough

Expansion

A periods of rising economic activity running from the trough to the subsequent next peak

What factors influence shifts in the Aggregate Production Function (Productivity Curve)

improvements or declines in technology, increases in physical capital (machinery, tools), enhancements in human capital (skills, education), growth in the labor force, availability of natural resources and changes in productivity itself

Diminishing returns to capital

Adding more units of capital (machines, tools) to a production process eventually yields smaller and smaller increases in output, assuming other factors (labor, technology) stay constant