ECON 4710: Aggregate Economic Analysis - Homework 3 Key Concepts

Vocabulary flashcards covering key macroeconomic concepts, formulas, and relationships from ECON 4710 Homework 3 (Chapters 4 and 6), including consumption choice, user cost of capital, investment decisions, goods market clearing, and growth accounting.

Current vs. Future Consumption Trade-off

The exchange rate between consumption today and consumption tomorrow; with zero inflation and a nominal interest rate $i$, trading off 1 unit of current consumption yields $1 + i$ units of future consumption.

Substitution Effect of the Real Interest Rate on Saving

The tendency of a higher real interest rate to increase the reward for saving, making future consumption relatively cheaper and leading a lender to decrease current consumption and increase saving when this effect dominates the income effect.

Expected Real After-Tax Interest Rate

The net real return earned on an asset after accounting for taxation of nominal interest and expected inflation, defined by the formula $r_{at} = (1 - t)i - \pi^e$, where $i$ is the nominal interest rate, $t$ is the tax rate, and $\pi^e$ is the expected inflation rate.

User Cost of Capital

The expected real cost of utilizing a unit of capital over a given period, equal to the sum of the real interest cost and depreciation cost: $uc = (r + d)P_K$, where $r$ is the expected real interest rate, $d$ is the depreciation rate, and $P_K$ is the price of capital goods.

Optimal Capacity Addition Rule

The decision rule dictating that a firm should expand factory capacity as long as the expected marginal product of capital is greater than or equal to the user cost of capital ($MPK^f \ge uc$).

Tax-Adjusted User Cost of Capital

The user cost of capital adjusted for corporate taxes; if a firm's expected marginal product of capital exceeds this cost, the firm increases its investment spending on capital goods.

Desired Capital Stock

The profit-maximizing level of capital chosen by a firm, which rises when the user cost of capital declines (such as from a decline in the expected real interest rate) and falls when the depreciation rate increases.

Gross Investment

The total amount of spending on capital goods during a period, calculated as net investment plus depreciation: $I_t = K_{t+1} - K_t + dK_t$.

Goods Market Equilibrium Real Interest Rate

The real interest rate $r$ at which desired national saving equals desired investment ($S^d = I^d$) at the full-employment level of output.

Total Factor Productivity (TFP) Growth

The portion of economic growth in output that cannot be accounted for by growth in capital inputs or growth in labor inputs.

Growth Accounting Equation

The relation expressing total output growth as the sum of productivity growth and the elasticity-weighted growth rates of capital and labor: $\frac{\Delta Y}{Y} = \frac{\Delta A}{A} + a_K\frac{\Delta K}{K} + a_N\frac{\Delta N}{N}$.

Contribution of Capital to Economic Growth

The fraction of real output growth attributable to changes in the capital stock, calculated as the capital elasticity of output multiplied by the percentage growth in capital ($a_K \frac{\Delta K}{K}$).

Contribution of Labor to Economic Growth

The fraction of real output growth attributable to changes in the labor supply, calculated as the labor elasticity of output multiplied by the percentage growth in labor ($a_N \frac{\Delta N}{N}$).