Midterm II Prep

Chapter 13: Saving, Investment, and the Financial System

National Income Accounting Identity

  • Formula: Y = C + I + G + (X - M)
    Y = GDP, C = Consumption, I = Investment, G = Government Spending, (X - M) = Net Exports

National Saving, Private Saving, Public Saving

  • National Saving (S) = Private Saving + Public Saving

  • Private Saving (Sₚ) = Income - Taxes - Consumption

  • Public Saving (Sᵖ) = Taxes - Government Spending

Saving and Investment

  • Investment is financed by savings, and the two are linked.

Budget Surplus and Budget Deficit

  • Budget Surplus: Government revenue > Government spending

  • Budget Deficit: Government revenue < Government spending

Tax and Investment (MPC)

  • The Marginal Propensity to Consume (MPC) affects investment. Higher MPC leads to less saving and less investment.

The Loanable Funds Market

  • A model that shows how saving and investment are determined.

    • Supply: Comes from savings

    • Demand: Comes from investment

    • Interest Rate: The price that balances supply and demand for loanable funds

How Government Policy Affects Equilibrium

  • Government policies (e.g., fiscal policy) can affect savings, investment, and interest rates.

Chapter 15: Unemployment

Measure Unemployment

  • Unemployment Rate = (Number of Unemployed / Labor Force) * 100

How to Measure

  • Based on surveys (e.g., the Current Population Survey) that categorize people as employed, unemployed, or not in the labor force.

Is It a Good Measure?

  • It has limitations, such as underreporting discouraged workers and part-time workers seeking full-time employment.

Natural Rate of Unemployment

  • The normal level of unemployment in an economy, consisting of frictional and structural unemployment.

Cyclical Unemployment

  • Unemployment caused by economic downturns or recessions.

Frictional Unemployment

  • Short-term unemployment that occurs when people are between jobs or entering the workforce.

Structural Unemployment

  • Long-term unemployment due to changes in the economy, such as technological advances or shifts in industries.

Three Reasons for Above-Equilibrium Wages

  1. Minimum Wage Laws

  2. Union Bargaining

  3. Efficiency Wages (wages higher than equilibrium to increase productivity)

Chapter 16: The Monetary System

Measures of Money Supply

  • M1: Currency, demand deposits, and traveler's checks

  • M2: M1 + savings deposits, money market mutual funds, and small time deposits

Money Supply and the Banking System

  • Banks create money through lending.

  • Money Multiplier = 1 / Reserve Ratio

How the FED Controls the Money Supply

  • The Federal Reserve controls money supply via open market operations, changing reserve requirements, and setting the discount rate.

Chapter 17: Money Growth and Inflation

The Quantitative Theory of Money

  • Formula: M V = P Y
    M = Money supply, V = Velocity of money, P = Price level, Y = Output (real GDP)

Money Supply-Demand Diagram

  • The supply of money is vertical (controlled by the central bank), while the demand for money slopes downward (based on interest rates).

Quantity Equation

  • MV = PY
    Shows the relationship between money supply, velocity, price level, and output.

In the Long Run: Monetary Neutrality and the Classical Dichotomy

  • Monetary Neutrality: In the long run, changes in the money supply affect only nominal variables (prices, wages) and not real variables (output, employment).

  • Classical Dichotomy: The separation of real and nominal variables in classical economics.

Fisher Effect

  • In the long run, an increase in the money supply leads to a proportional increase in the price level, causing inflation to rise at the same rate.

Cost and Benefit of Inflation

  • Costs: Distorts prices, reduces purchasing power, can lead to uncertainty

  • Benefits: Reduces real value of debt, allows for nominal wage flexibility