Short Run Keynesian Model

What determines aggregate prices and output?

the interaction of aggregate supply and demand

*if price up, profit is up, and Qs is up

What determines interest rates?

Money Supply and demand determines interest rates

(MS up (money is not worth as much/ can't buy as many goods, interest rates down) since people are saving less and spending more

What are the components of aggregate demand?

AD= Consumption + Investment + Government Spending + Net Exports

aka GDP = Aggregate Demand

*consumption is the largest component; 2/3 of GDP in recent years

What are the determinants of Consumption? Saving? Investment? Government
Expenditures? Exports? Imports?

Consumption= disposable income, (Y-T)

Saving = determined by interest rates ( interest up, saving more, invest less)

Investment= determined by interest rates (interest down, investment up)

Government Expenditures= determined by government spending decisions

Exports= determined by foreign income and outputs, ratio of domestic to foreign prices and exchange rate

Imports= determined by domestic income and outputs, ratio of foreign to domestic prices, and foreign exchange rate to the dollar

What are the condition(s) for short-run macro equilibrium?

where AS and AD cross, AS = AD

planned investment = actual investment
S=I

AD determines output (supply)

Paradox of Thrift

short run: saving up, CONSUMPTION down, demand down, prices/ output down

long run: saving up, INVESTMENT up, demand up, prices/output up

What is the role of inventories (what makes them go up or down and what does each signify)?

counts as capital, unused production

What factors shift the aggregate demand curve? The aggregate supply curve?

AD shifts:
-foreign output
-asset value
-technology
-politics and war

AS shifts:
-input
-production costs
-technology
-potential output

How does the stock market affect the economy?

-increases in stock prices increases household wealth
-helps distribute wealth, equitable but not wealth
-affects wealth, therefore consumption

What are the 'types' of unemployment?

Structural= mismatch b/w the supply and demand for workers, demand of one kind of labor is rising; while demand for another is falling

Cyclical= overall demand for labor declines in business-cycle downturns

Equilibrium/ Frictional= voluntary unemployment as people move from job to job or out/into labor force (teenagers)

Structural and Cyclical are not at equilibrium

What is inflation and what causes it in the short-run?

Inflation is a general rise in overall prices; uses CPI as calculation

Caused By:
Demand Pull/Demand Shock = AD rises, Prices rise

Cost Push/ Supply Shock= AS decreases due to the cost of production
Prices rise, Output Down

Shoe Leather Costs increases inflation b/c people inefficiently relinquish their money to try and counteract inflation

Menu Costs= the costs incurred in changing things to fix prices (printing new menus)

Stagflation and Deflation in the short run

stagflation is the coexistence of high unemployment and persistent inflation; no economic growth

deflation is a general fall in overall prices

Lenders and Borrowers Relation

Lenders lose to borrowers because the money they lend is paid back with money that is worth less

What is the short-run Phillips curve and why is it important?

Short-run Philips curve= representation of the inverse relationship b/w inflation/unemployment

Rule of 72 = years to double = 72/growth rate
^ a method of estimating how long it will take compounding interest to double an investment

What causes business cycles, and what are they?

business cycles= periodic, irregular, ups and downs in economic activity

caused by shifts in AS and AD, exogenous variables (wars, politics, etc.)

How does monetary policy impact the economy in the short-run?

control of the money supply affects interest rates

Monetary Policy impacts prices

How does fiscal policy impact the economy?

direct government spending/ tax adjustments affect AD
*everything increases when government spending increases ; G, D, (p,y) up

Fiscal Policy has no impact on P or Y (just I)

What is the effect of a government budget deficit?

deficit= spending more than bringing in

government expenditures are greater than government revenues

Short run: G up, D up, (p,y) up = good
Long Run: foreigners are buying our bonds which is bad, debt up

Which is the shorter and which the longer lag in fiscal policy?

Fiscal policy

Long implementation lag (slow)
Short Impact lag (quick)

What is the idea of the political business cycle?

Seems like economy is doing well because candidates spend more when elections are near so that they try to make the situation look better than it is

What is a consumption function? The mpc? the multiplier?

Consumption function= a mathematical formula laid out by famed economist John Maynard Keynes. The formula was designed to show the relationship between real disposable income and consumer spending

MPC= amount people consume when they receive an extra dollar of disposable income

MPS= fraction of an extra dollar that you save

MPC+ MPS= 1

Multiplier= explains how changes in spending affects translates to changes in output(short-run) and employment

Change in output =
1/MPS * change in investment

1/(1-MPC) * change in investment

Calculate the Government Expenditure multiplier

Formula:
1/(1-MPC)

Increase in G will increase D(demand) and y (output)
b/c y increases, there will be an increase in C (consumption) therefore further increase in D and then y

In the simplest case, which is larger, the government expenditure or the tax multiplier?

Government expenditure is larger than the tax multiplier

What is the wealth effect?

feel richer, spend more

demand goes up; prices and output goes up

What is the relation between saving and consumption?

S= Y-C

saving = output - consumption

What is the effect of an increase in saving in the short run?

S up -> C down -> D down -> y down

What is the effect of an increase in investment in the short-run?

I up -> C up -> Y up