Macroeconomics Midterm 2

Consumption Function

the relationship between consumption and income (o.t.c.)

Marginal Propensity To Consume (MPC)

the fraction of a change in income that is spent on consumption; the change in consumption divided by the change in income that caused it

Marginal Propensity To Save (MPS)

fraction of a change in income that is saved; the change in income that caused it

Saving Function

the relationship between saving and income (o.t.c.)

Net Wealth

the value of assets minus liabilities

Life-Cycle Model of Consumption and Saving

young people borrow, middle-agers pay off debts and save, and older people draw down their savings; on average net savings over a lifetime are small

Investment Function

the relationship between the amount businesses plan to invest and the economy's income (o.t.c.)

Autonomous

a term that means "independent"; for example, autonomous investment is independent of income

Government Purchase Function

the relationship between government purchases and the economy's income (o.t.c.)

Net Exports

the relationship between net exports and the economy's income (o.t.c.)

Spending > Real GDP

-inventory reduction

-increase production, employment, income, and spending

Real GDP > Spending

-unsold goods = unplanned inventory buildups

-decrease production, employment, income, and spending

Simple Spending Multiplier

a ratio of change in real GDP demanded to the initial change in spending that brought it about (assuming only consumption varies with income)

Spending > Output Round 1

-unplanned reduction in inventories

-expand production

-increased income

Spending > Output Round 2

-increased spending and saving

-increased output

-increased income

Spending > Output Round 3+

-increased spending and saving

-increased output

-increased income

Aggregate Supply

the relationship between the economy's price level and the amount of output firms are willing and able to supply, o.t.c.

(labor is the most important resource, accounting for about 70% of production costs)

Nominal Wages

the wage measured in dollars of the year in question: the dollar amount on the paycheck

Real Wage

the wage measured in dollars of constant purchasing power; the wage measured in terms of the quality of goods and services it buys

Potential Output

the economy's maximum sustainable output, given the supply of resources, technology and know-how, and rules of the game; the output level when there are no surprises about price level

Natural Rate of Unemployment

the unemployment rate when the economy produces its potential output

Short Run

in macroeconomics, a period during which some resource prices, especially those for labor, remain fixed by explicit or implicit agreements

Short Run Aggregate Supply (SRAS) Curve

a curve that shows a direct relationship between the actual price level and real GDP supplied in the short run, (o.t.c.), including the expected price level

Short Run Equilibrium

the price level and real GDP that result when the aggregate demand curve intersects the short run aggregate supply curve

Expansionary Gap

the amount by which actual output in the short run exceeds the economy's potential output

Long Run

in macroeconomics, a period during which wage contracts and resource price agreements can be renegotiated; there are no surprises about the economy's actual price level

Long Run Equilibrium

the price level and real GDP that occur when

1. the actual price level equals the expected price level

2. real GDP supplied equals potential output

3. real GDP supplied equals real GDP demanded

Recessionary (Contractionary) Gap

the amount by which actual output in the short run falls short of the economy's potential output

Long Run Aggregate Supply (LRAS) Curve

vertical line at the economy's potential output; aggregate supply when there are no surprises about the price level and all resource contracts can be negotiated

Supply Shocks

unexpected events that affect aggregate supply, sometimes only temporary

Beneficial Supply Shocks

unexpected events that increase aggregate supply, sometimes only temporarily

Adverse Supply Shocks

unexpected events that reduce aggregate supply, sometimes only temporarily

Hysteresis

the theory that the natural rate of unemployment depends in part on the recent history of unemployment; a long period of high unemployment can increase the natural rate of unemployment

Automatic Stabilizers

structural features of government spending and taxation that reduce fluctuations in disposable income and thus consumption, over the business cycle

Discretionary Fiscal Policy

the deliberate manipulation of government purchases, taxation, and transfer payments to promote macroeconomic goals, such as full employment, price stability, and economic growth

Simple Tax Multiplier

the ratio of a change in real GDP demanded to the initail change in autonomous net taxes that brought it about; the numerical value of the simple tax multiplier is MPC/(1-MPC)

Expansionary Fiscal Policy

an increase in government purchases, decrease in net taxes, or some combination of the two aimed at increasing aggregate demand enough to return the economy to its potential output, thereby reducing unemployment; policy used to close a contradictory gap

Contractionary Fiscal Policy

a decrease in government purchases, increase in net taxes, or some conbination of the two aimed at reducing aggregate demand enough to return the economy to potentail output without worsening inflation; policy used to close an expansionary gap

Classical Economists

a group of 18th and 19th century economists who beleived that economic downturns were short run phenomena that corrected themselves through natural market forces; thus, they beleived the economy was self-correcting

The Banking Act of 1933

created the FDIC to back and insure savings, it also separated commercial banking from investment banking

The Banking Act of 1935

restructured the Federal Reserve, giving it more independence from the executive branch, and the financial system

The Great Depression

at its height, 25% of the working population was unemployed

(although employment dropped after 1933, the "invisible hand")

John Maynard Keynes: The General Theory of Employment, Interest, and Money (1936)

-price and wages inflexible in a downward direction and natural market forces were not correcting

-even with lower interest rates, bleak business expectations

Three developments bolstered the use of discretionary fiscal policy in the U.S.

1. with the economy operating below its potential, the governement needed to increase aggregate demand to boost output and employment

2. WWII lifted U.S. out of the depression

3. Employment Act of 1946

Employment Act of 1946

gave the federal government responsibility for promoting full employment and price stability

Overall impact of fiscal policy

don't worry about a balanced budget, promote full employment and price stability

Automatic Stabilizers (2)

smooth out fluctuations in disposable income over the business cycle, thereby stimulating aggregate demand during recessions and dampening aggregate demand during expansions

The Revenue Act of 1945

reduced the invididual income tax rate by 3 percentage points

Progressive Income Tax

during economic expansion and recession

Unemployment Insurance

during economic expansion, the system automatically increases the flow of unemployment insurance taxes from the income stream into the unemployment insurance fund, moderating aggregate demand

Golden Age to Stagflation

1960s: Golden Age of Keynesian Economics

President Kennedy: proposed a federal budget deficit

President Johnson: cut taxes

Great Society

Discretionary Fiscal Policy

a demand management policy; the objective is to increase or decrease aggregate demand to smooth economic fluctuations

1970s

Stagflation

-high unemployment, high inflation resulting from a decrease in aggregate supply

1980s

The Supply Side Experiment

-president: 23% tax cut

-government spending

-the stimulus from the tax cut helped sustain a continued expansion during the 1980s (longest peacetime)

-national debt strongly increased

1990s

Errors of Judgement and Reasoning

-Clinton: (1933) substantially increased taxes on high income houses

-1934: more discipline on federal spending

-economy recovered: growing consumer spending, rising business optimism, globalization, and bull market

October 2008

TARP (Troubled Asset Relief Program) was about bailing people and companies (banks) out of bankrupcy

4th quarter of 2008

real GDP fell 8.9%, unemployment went from 5.0 to 7.4%

Recovery and Reinvestment Act: February 17, 2009

$787 billion of tax benefits and spending programs aimed at stimulating aggregate demand

Banks subjected to Stress Tests

-some had little negotiation time for more asset injection

-FDIC closed 465 banks from 2008-2012

-$250,000 Deposit Insurance

-Wells Fargo took over Wachovia

President Obama (January 2009)

-issued tax cut

-intervened more directly in the economy

-asked some CEOs to resign to get federal aid

-"days of the million dollar bonuses are over"

Cash for Clunkers (June 2009)

approved $1 billion to pay from $350-4500 to each car buyer who traded in a "clunker"

President Trump (2016)

-produces tax cut for businesses and taxpayers

-$200,000-450,000

-economy was recovering

-stocks: large big and lows

-restaurant and retail still struggled

-immigration tightened

Double Coincedence of Wants

two traders are willing to exchange their products directly

Money

anything that is generally accepted in exchange for goods and services

Money Fufills 3 Functions

medium of exchange, a unit of account, and store of value

Medium of Exchange

anything that facilitates trade by being generally accepted by all parties in payment for goods and services

Commodity Money

anything that serves both as money and a commodity; money that has intristic value

Unit of Account

a common unit for measuring the value of each good or service

Store of Value

anything that retains its purchasing power over time

Gresham's Law

people tend to trade away inferior money and hoard the best

-bad money drives out good-debasing coinage

-money should maintain a relatively stable value

Seignorage

the difference between the face value of money and the cost of supplying it; the "profit" from issuing money

-U.S. coin production: a quarter costs 3 cents to make

-the U.S. Mint made $165 million in 2024

Token Money

money whose face value exceeds its cost of production

Check

a written order instructing the bank to pay someone from an amount deposited

Transactions Account

a bank account that permits direct payment to a third party- a check or debit card

Fractional Reserve Banking System

only a portion of bank deposits are backed by reserves

Bank Notes

originally, papers promising a specific amount of gold and silver to anyone who presented them to issuing banks for redemption; today, Federal Reserve notes are mere paper money

Representative Money

bank notes that exchange for a specific commodity, such as gold or silver

Flat Money

money not redeemable for any commodity; its status as money is conferred initially by the government, but eventually by common experience

Legal Tender

U.S. currency that constitutes a valid and legal offer of payment of debt

Financial Institutions

-financial intermediaries

-depository institutions

-commercial banks

-thrift institutions

Financial Intermediaries

institutions that service as go-betweens, accepting funds from savers and lending them to borrowers

Depository Institutions

commercial banks and thrift institutions; financial institutions that accept deposits from the public

Commercial Banks

depository institutions that historically make short-term loans, primarily to businesses

Thrift Institutions

savings banks and credit unions; depository institutions that historically lent money to households

The National Banking Act of 1863

created a new system of federally charted banks called National Banks

-they issued notes

-regulated by the Comptroller of the Currency

-state notes were all taxed out of existence

-state banks survived by creating checking accounts

-we have dual banking system

1907

Knickerbocker Trust Company failed

1913

created the Federal Reserve system

Federal Reserve System

-central band and monetary authority of the U.S

-to serve as the central bank and monetary authority

-all banks were required to join (except state bank)

-now issued all notes

Federal Reserve System (other powers)

-buy and sell government securities

-to extend loans to member banks

-to clear checks

-to require that member banks hold reserves equal to at least some specified fraction of their deposits

Reserves

funds that banks use to satisfy the cash demands of the customer and reserve requirements of the FED; reserves consist of cash held by banks plus deposits at the FED

Banking During the Great Depression

1913-1929: FED performed up to expectations

1933: FED practiced conservative money practices

1933: President Franklin D Roosevelt declared a banking holiday

Banking Acts of 1933 and 1935

two acts brought regulation to the banking system and centralized power with the FED

Reserves (2)

funds that banks use to satisfy the cash demands

Overall Objections of the FED

to maintain...

1. a high level of unemployment in the economy

2. economic growth

3. price stability

4. interest rate stability

5. financial market stability

6. exchange rate stability

Bank Branches

a bank's additional offices that carry out banking operations

Bank Holding Company

a corporation that owns banks

Money Market Mutual Fund

a collection of short-term interest-earning assets purchased with funds collected from many shareholders

-introduced by Merrill-Lynch in 1972

-became competition for banks

-people were attracted to this type of investment because of inflation of the 1970s

Moral Hazard

banks continued to take bigger risks since they felt their depositors would be protected by the Federal Deposit Insurance Corporation

S & L Crisis (Savings & Loans)

by the late 1980s, a large number of banks collapsed or declared insolvency

Subprime Mortgages and Mortgage-Backed Securities

-before 2000 you had to be a credit-approved customer to get a mortgage loan

-after 2000 lenders began using new statistical and data gathering to better determine the risk of a subprime mortgage

-a credit score determined how likely a borrower was to default on their mortgage payments