Econ Final part 3

What is a deficit

when spending is greater than income

What is a surplus

when income is greater than spending

What is a cyclical deficit?

A deficit because the economy is below potential output

What is a structural deficit

a deficit that would exist even if the economy is at potential output

what is total deficit? **the equation

cyclical + structural deficit

What is debt? **equation

deficits - surpluses (is a flow!)

How are deficits financed?

by selling government securities

How should deficits, debt, and surpluses be viewed?

in relation to the GDP ration

What is public debt?

ongoing (bonds are being sold/payed offs)

What is private debt?

backed by assets (mortgage and houses)

3 strategies to reduce debt?

budget adjustments
GDP growth
Inflation (debt/GDP ratio decreases)

What is internal debt?

owed to its agencies or to its citizens

What is fiscal policy?

the government use of spending and taxation

Expansionary fiscal policy

increase spending / reduce taxes

Contractionary fiscal policy

decrease spending / increase taxes

What is the Ricardian Equivilence theorem?

It does not matter how a government finances its spending, there will be no affect of AD

What are Automatic stabilizers?

government policy that will counteract the business cycle without new government action

What do automatic stabilizers do?

reduce the extremes of the business cycle ex. unemployment insurance

What is pro-cyclical policy?

changes in government spending to enhance fluctuations in the business cycle

What is counter-cyclical policy?

changes in government spending to reduce fluctuations in the business cycle

What is the fiscal dilemma?

that expansionary fiscal policy will be ineffective due to high GDP/debt ratios

What is fiscal consolidation?

government policies aimed to reduce deficits and the accumulation of debt

What are the three methods of fiscal consolidation (reduce deficits!)

target the debt ratio
budget adjustments
inflation

What did the budget adjustment do?

contributed more to reducing the GDP to debt ratio than GDP growth

What are the neoclassical worries of fiscal policy

concerned that government spending reduces private spending (crowding out)

What is the labor force

all the people who are able and willing to work

What is the unemployment rate? ** equation

unemployed / labor force

3 issues with the unemployment rate & their estimations

discouraged workers - underestimation
work part time & want full time - underestimation
informal sector - overestimation

What is okun’s rule of thumb?

a 1% change in unemployment leads to a 2% change in output

What is the target rate of unemployment?

lowest sustainable rate of unemployment

Why has the target rate of unemployment increased?

structural changes
unemployment benefits have increased

Natural rate of unemployment

rate of unemployment if were at potential output

How do you calculate the labor force?

civilian - incapable - unwilling

How do you calculate the unemployed?

labor force - employed

What is inflation?

rise in price level

What is the price index?

number that summarizes what happens to the prices of a good/service over time

What is the inflation equation?

(new expenditures - old expenditures) / old expenditures

What is the consumer price index

a measure of how everyday goods and services have changed over time * only bought by consumers & overestimation bc of substitution

What is the GDP deflator

used to measure price changes over time, only domestic goods, measures ALL goods and services

How do expectations play a role in inflation?

it gives income from lenders to distributors

Demand pull inflation

increased demand in limited supply (result of excessive monetary/fiscal policy)

Cost push inflation

due to increases in cost production (when nominal wages increase more than productivity)

Quantity theory of inflation

increase in money supply (if money supply rises, the price level rises) (MV = PQ where PQ is nominal output)

Institutionalist theory of inflation

increase in money supply- a reaction to wage/cost increases
(increased wages mean institutions make individuals pay higher prices so the government increases the money supply)

What is the nominal GDP equation

Nominal GDP = (Real GDP x GDP deflator) / 100

What do neoclassical economists believe about inflation

that expansionary policy creates inflation

What does the Philips curve show?

inverse relationship between inflation and unemployment

Stagflation

no economic growth and inflation

Long-run Phillips curve

vertical, no long-relationship between inflation and unemployment

Non-accelerating inflation rate of unemployment

theoretical level of unemployment where inflation would be expected to rise

What do Keynesians believe about the Philips Curve?

that the short run philips curve will hold of the economy is in a recession

What do neoclassical believe about the philips curve

that there is never an inverse relationship between inflation and unemployment

Why are PPC’s curved?

because we only get partial specialization

What are the gains of trade?

lower prices (harder to see) than the costs (lost jobs)

What are some comparative advantages in the U.S.

research, technological infrastructure

What does wealth from the past mean?

wealth from past production and exports allows the U.S. to import more than we export

What is inherent comparative advantage?

based on unchangeable factors like climate

What is transferable comparative advantage?

factors that change relatively easy like capital and technology

What is the law of one price?

identical goods sold in different locations will sell for the same price in the long-run, except for costs associate with movement (outsourcing)

Outsource

firms move their production to other countries with cheaper labor

3 sources of demand for the U.S dollar and foreign currency

1. foreign households want to but goods and services produced in the U.S

2. Foreigners want to invest in the U.S.

   1. Currency speculators believe the future of the dollar will be greater

Globalization

overall integration of national economies

Internationalization of production

companies expand beyond their home country:
factories across the world
intermediate products produced here

What is the convergence hypothesis?

wages in developing countries will rise in the future
allows U.S. to regain comparative advantage in manufacturing

Exchange rate

determines how much an imported product costs in terms of domestic currency

What needs to happen to regain a comparative advantage in goods

the U.S. dollar needs to decline:
U.S exports will become cheaper for foreigners

What does an increase in demand of U.S. dollar mean?

increase in supply of foreign currency

two parts of globalization

1. international trade, global flow of information

2. homogenization of policies (uniform laws across different countries)

What are the four components of the balance of payments?

1. exports and imports

2. income on foreign investments

3. foreign aid

4. foreign investment

Flows in financial assets are…

part of the financial account, the U.S. has a large financial account surplus

Why does the BoP have a deficit?

because the current account deficit is larger than the surplus in the financial account

Protectionism

restricts international trade to protect from foreign competition (we don’t want to be depended on other countries)

What are three oppositions to trade restrictions?

1. trade increases total global output

2. trade provides competition for domestic companies

3. trade makes production more efficient

trade balance

difference between the value of exports and imports

trade deficit

imports > exports

How is the current account deficit being financed?

by selling financial assets and real assets

What are the two components of the U.S. BoP?

the current account and the financial account

How to protect our farmers?

tariffs
quotas- quantities placed on imports
subsidies- domestic products become cheaper than foreign ones
regulatory trade restrictions- procedural rule ex. shrimp in bangladesh

Determinants of the exchange rate (3!)

1. trade (growth and prices)

2. foreign investment (interest rate and capital flows)

3. currency speculation

How does growth lead to the devaluation of currency?

U.S. income increases more than foreigners - imports increase - demand for foreign currency to buy imports increases - more dollars

Macroeconomic factors of international financial policy

1. GDP growth

2. changes in price level

3. changes in interest rates

How does a price increase cause a devaluation of the dollar?

increase in the price level in the U.S - imports increase because U.S. goods are more expensive - the demand to buy more imports increases, increasing the demand for foreign currency - dollar depreciates

How does an interest rate increase cause the appreciation of the dollar

increase on the interest rate on U.S. dollar assets - demand to buy U.S. assets increases- demand for U.S. dollar- appreciation

Two ways of exchange rate interventions

1. buying currencies causes appreciation in that currency

2. Fed can sell dollars to lower the value of the dollar, but it cannot make it stronger

Currency stabilization

buying/selling currency stops fluctuations
keeps exchange rate at long-run equilibrium

purchasing power parity

determines the exchange rate between two currencies that would allow you to buy the same amount of goods in each country

Advantages of a stronger dollar

foreign currency is cheaper, so imports are cheaper
cheap imports help keep our inflation rates low

Disadvantages of a strong dollar

imports increase causing a trade deficit

Advantages of a trade surplus

jobs, accumulate foreign assets

Disadvantages of a trade surplus

potential inflation, degradation of resources

Increase the trade deficit? No

once foreigners stop buying U.S assets the U.S dollar will
depreciate
increase U.S. exports

Consequences of Increase the trade deficit?

the fall of the dollar increases the prices of imports, creating inflation