University of Arkansas Balthrop Macroeconomics Final Exam

Economic growth-

an increase in the amount of goods and services produced per head of the population over a period of time.

Gross Domestic Product (GDP)

the total value of goods produced and services provided in a country during one year. Y=C+I+G+NX

Inflation

a general increase in prices and fall in the purchasing value of money.

Recession-

a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP

Rule of 70-

a means of estimating the number of years it takes for an investment or your money to double. Number of years to double=70/annual percentage growth rate

Human Capital-

the skills, knowledge, and experience possessed by an individual or population, viewed in terms of their value or cost to an organization or country.

Social Capital-

the networks of relationships among people who live and work in a particular society, enabling that society to function effectively.

Institutions-

a company or an organization that deals with money or with managing the distribution of money, goods, and services. Ex: Bank, Government Organizations

Natural Resources-

materials or substances such as minerals, forests, water, and fertile land that occur in nature and can be used for economic gain.

Physical Capital-

a factor of production (or input into the process of production), consisting of machinery, buildings, computers, etc. It is divided into 2 categories-working and fixed capital.

Private Property Rights-

the theoretical and legal ownership of resources and how they can be used. These resources can be both tangible or intangible and can be owned by individuals, businesses, and governments.

Production Function-

equation that expresses the relationship between the quantities of productive factors (such as labor and capital) used and the amount of product obtained. Y=f (K, L, etc.)

Steady State-

An unvarying condition in an economic process

Depreciation-

a decrease in the value of a currency relative to other currencies.

Net Investment-

the amount spent by a company or an economy on capital assets, or gross investment, less depreciation.

Convergence-

the hypothesis that poorer economies' per capita incomes will tend to grow at faster rates than richer economies. As a result, all economies should eventually converge in terms of per capita income.

Aggregate Demand-

the total demand for goods and services within a particular market.

Aggregate Supply-

the total supply of goods and services available to a particular market from producers.

Wealth-

an abundance of valuable possessions or money.

Wealth Effect-

a behavioral economic theory suggesting that people spend more as the value of their assets rise. The idea is that consumers feel more financially secure and confident about their wealth when their homes or investment portfolios increase in value.

Interest Rate Effect-

the fact that most consumers and business finance managers will cut back on their borrowing activities when interest rates increase.

International Trade Effect-

How the price level of a product will affect net exports and imports on the same product.

Long-run-

a period of time in which all factors of production and costs are variable

Short-run-

a concept that states that, within a certain period in the future, at least one input is fixed while others are variable.

Supply Shock-

an unexpected event that suddenly changes the supply of a product or commodity, resulting in an unforeseen change in price.

Monetary Policy-

the process of drafting, announcing, and implementing the plan of actions taken by the central bank, currency board, or other competent monetary authority of a country that controls the quantity of money in an economy and the channels by which new money is supplied.

Fiscal Policy-

the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy.

Classical Economists-

Original founders of economics. Adam Smith, David Ricardo, Thomas Malthus

Keynesian Economists-

an economic theory of total spending in the economy and its effects on output and inflation. Advocated for increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the depression.

Transfer Payments-

a payment made, or income received in which no goods or services are being paid for, such as a benefit payment or subsidy.

Government Outlays-

The breakdown of the government's expenditure. All the payments the government makes throughout the year.

Mandatory Outlays-

government spending on certain programs that are mandated by law.

Discretionary Outlays-

government spending implemented through an appropriations bill. This spending is an optional part of fiscal policy, in contrast to entitlement programs for which funding is mandatory and determined by the number of eligible recipients.

Social Security-

any government system that provides monetary assistance to people with an inadequate or no income.

Medicare-

the federal government program that provides health care coverage (health insurance) if you are 65+, under 65 and receiving Social Security Disability Insurance (SSDI) for a certain amount of time

Marginal tax rate-

the rate at which tax is incurred on an additional dollar of income.

Average tax rate-

the tax rate you pay when you add all sources of taxable income and divide that number into the amount of taxes you owe. In other words, you can calculate your average tax rate by dividing your total tax obligation by your total taxable income.

Progressive Income Tax-

a tax that imposes a lower tax rate on low-income earners compared to those with a higher income, making it based on the taxpayer's ability to pay.

Budget Deficit-

expenses exceed revenue and indicate the financial health of a country. The government generally uses the term budget deficit when referring to spending rather than businesses or individuals. Accrued deficits form national debt.

Government Debt-

the public and intragovernmental debt owed by the federal government.

Austerity-

a set of political-economic policies that aim to reduce government budget deficits through spending cuts, tax increases, or a combination of both. It generally increases unemployment as government spending falls.

Expansionary Fiscal Policy-

a form of fiscal policy that involves decreasing taxes, increasing government expenditures or both, in order to fight recessionary pressures.

Contractionary Fiscal Policy-

a form of fiscal policy that involves increasing taxes, decreasing government expenditures or both in order to fight inflationary pressures.

Keynesian spending multiplier-

an economic theory that asserts that an increase in private consumption expenditure, investment expenditure, or net government spending (gross government spending - government tax revenue) raises the total Gross Domestic Product (GDP)

Automatic Stabilizers-

a type of fiscal policy designed to offset fluctuations in a nation's economic activity through their normal operation without additional, timely authorization by the government or policymakers

Laffer Curve-

a supposed relationship between economic activity and the rate of taxation that suggests the existence of an optimum tax rate that maximizes tax revenue.

Barter-

exchange (goods or services) for other goods or services without using money.

Commodity Money-

money whose value comes from a commodity of which it is made. Has intrinsic value, Ex: Gold Coins

Fiat Money-

inconvertible paper money made legal tender by a government decree.

M1-

a narrow measure of the money supply that includes physical currency, demand deposits, traveler's checks, and other checkable deposits. M1 does not include financial assets, such as savings accounts and bonds

M2-

a calculation of the money supply that includes all elements of M1 as well as "near money." Includes all the things that are excluded from M1

Fractional reserve banking-

a system in which only a fraction of bank deposits is backed by actual cash on hand and available for withdrawal. This is done to theoretically expand the economy by freeing capital for lending.

Bank run-

occurs when a large number of customers of a bank or other financial institution withdraw their deposits simultaneously over concerns of the bank's solvency. As more people withdraw their funds, the probability of default increases, prompting more people to withdraw their deposits.

Required reserve ratio-

the fraction of deposits that regulators require a bank to hold in reserves and not loan out.

Moral hazard-

lack of incentive to guard against risk where one is protected from its consequences, e.g. by insurance.

Money multiplier-

The ratio of deposits to reserves in the banking system. The amount of money that banks generate with each dollar of reserves.

Federal Funds Rate-

the interest rate that banks charge other banks for lending them money from their reserve balances on an overnight basis.

Discount Rate-

the minimum interest rate set by the Federal Reserve for lending to other banks.

Open Market Operations-

When the Federal Reserve buys or sells securities from its member banks

Adaptive Expectations-

a hypothesized process by which people form their expectations about what will happen in the future based on what has happened in the past.

Rational Expectations-

individuals base their decisions on three primary factors: their human rationality, the information available to them, and their past experiences.

Describe the capital accumulation equation, in particular the role of investment in forming new capital.-

a. K'= (1-d) K + sY b. Capital is the multiple and the factor that helps it grow the most.

Explain the Solow model and how the steady state level of capital is endogenous based on the rate of savings. According to the simplest form of the Solow model, what is the long-term source of economic growth?-

Technology

Besides physical capital describes the other sources of economic growth (including, human capital, social capital, institutional capital, geographic and natural capital).-

human capital- the skills, knowledge, and experience possessed by an individual or population, viewed in terms of their value or cost to an organization or country. social capital- the networks of relationships among people who live and work in a particular society, enabling that society to function effectively. institutional capital- the total of the credit union's regulatory reserve accounts, undivided or retained earnings, special reserves, and net income that has yet to be closed to the retained earnings account. geographic and natural capital- the world's stocks of natural assets which include geology, soil, air, water and all living things. It is from this natural capitalthat humans derive a wide range of services, often called ecosystem services, which make human life possible.

What affect would an increase in the savings rate have on stead-state capital per worker? Output per worker? Show this using the Solow model.-

It would shift the green line up

Isaac Asimov's Foundation trilogy describes the technological collapse of an empire. The collapse is slow and begins when society reaches a level of complexity where a generation is unable to match the understanding and achievements of their parents. What effect would this have on output and capital per worker as the PPF shifts inward? Show this using the Solow model.-

All three lines would shift toward the y axis indicating that the economy is beginning to crash.

What does aggregate demand represent? What are its endogenous components? What are its exogenous components (i.e., the "shifters")?-

a. All the demand of all the products in a market b. People simply wanting to buy more things c. Wealth effect, Interest rate effect, international trade effect

What does aggregate supply represent? What are its endogenous components? What are its exogenous components?-

a. All the supply of all products in a market b. People wanting to produce more c. Resource prices, productivity, taxes and subsidies, government regulations

Qualitatively, we can think of 4 different economic scenarios in which the economy is out of its long-run equilibrium. Explain each in turn, including (i) what happens to GDP and inflation, (ii) how the economy returns to equilibrium in the absence any policy intervention. a. Aggregate supply increase b. Aggregate demand increase c. Aggregate supply decrease d. Aggregate demand decrease-

a. Inflation increases, GDP increases b. Demand will decrease over all driving prices down c. See shifters for a-d

What is fiscal policy? How does it affect the economy?-

the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. How the government controls the supply and demand in the given economy

What is monetary policy? How does it affect the economy?-

the process of drafting, announcing, and implementing the plan of actions taken by the central bank, currency board, or other competent monetary authority of a country that controls the quantity of money in an economy and the channels by which new money is supplied. How the government controls the money supply in the economy.

Explain how monetary or fiscal policy can be used to "treat" the economic disequilibria in problem 8.-

It allows the government to increase expenditure or decrease it

According to economists, money must provide three functions. Explain them.-

a. Medium of Exchange- A constant measure of goods b. Unity of Account- Able to accurately value items c. Store of Value- Holding intrinsic value within it

Explain how fractional reserve banking allows banks to create new money.-

It allows the bank to create new money by charging interest on money that is lent out in various forms.

Explain how fiscal policy can result in crowding out and lowered long-run growth.-

A situation when increased interest rates lead to a reduction in private investment spending such that it dampens the initial increase of total investment spending is called crowding out effect.

banking liquidity crisis-

Investors prefer cash or highly liquid assets on long term investments because they have a higher risk

banking solvency crisis-

When a country has debts that it can't meet through its assets. i.e. even if it could sell all its assets, it would still be unable to repay its debts

Explain why the economy is particularly fragile to banking/financial crises.-

So much of the economy relies on consumers and their preferences. It is very hard to predict what consumers will do, making it hard for banks to plan accordingly.

Explain the cause and course of the Great Depression-

Distrust in banks, bank run, everyone withdrew, not enough money for everyone to withdraw at once, market crashed. Rebuilt itself with government programs that pumped money back into economy.

Explain the cause and course of the Great Recession.-

Major causes of the initial subprime mortgage crisis and following recession include: International trade imbalances and lax lending standards contributing to high levels of developed country household debt and real-estate bubbles that have since burst; U.S. government housing policies; and limited regulation of non-depository financial institutions.

Compare and contrast the Keynesian school of economics to the Classical school.-

The major difference is the role government plays in each. Classical economics is essentially free-market economics, which maintains that government involvement in managing the economy should be limited as much as possible. Keynesian economics espouses the view that government should take an active role in managing the economy, particularly in depression/recession like periods. When the economy is doing well, both theories take a hands-off approach and tend to let the economy grow to its maximum potential rather than interfere.