Finals Review

StudyBlue printing of Finals Review html, body, div, span, applet, object, iframe, h1, h2, h3, h4, h5, h6, p, blockquote, pre, a, abbr, acronym, address, big, cite, code, del, dfn, em, font, img, ins, kbd, q, s, samp, small, strike, strong, sub, sup, tt, var, b, u, i, center, fieldset, form, label, legend, table, caption, tbody, tfoot, thead, tr, th, td { margin: 0; padding: 0; border: 0; outline: 0; font-size: 100%; background: transparent; } body { line-height: 1; } blockquote, q { quotes: none; } blockquote:before, blockquote:after, q:before, q:after { content: ''; content: none; } /* remember to define focus styles! */ :focus { outline: 0; } /* remember to highlight inserts somehow! */ ins { text-decoration: none; } del { text-decoration: line-through; } /* tables still need 'cellspacing="0"' in the markup */ table { border-collapse: collapse; border-spacing: 0; } /* end RESET */ .header { min-width:800px; } .logo { padding:6px 20px 2px 20px; margin:0; font-size:25px; font-weight:bold; color:#808285; position:relative; border-bottom: 1px solid #c5c5c5; } .logo-blue { color:#70adc4; } .logo-desc { font-weight:normal; font-size:19px; color:#cccccc; margin-top:50px; position:absolute; display: none; } .back-button { position:absolute; top:20px; right:20px; font-size:13px; line-height:25px; color:rgb(0,175,225); font-weight:normal; } .back-button a { color:rgb(0,175,225); } .instructions { padding:0; margin:0; width:100%; position:relative; color:rgb(100,100,100); } .step-holder { border-left:1px solid #ededed; margin-left:20px; } .steps { padding:15px 0; float:left; width:24%; border-right:1px solid #ededed; text-align:center; } .steps-01 { } .steps-02 { } .steps-03 { } .steps-04 { } .label { padding:5px 10px; } .print-button { } .print-button a { background-color:rgb(0,175,225); color:white; line-height: 19px; padding:9px 8px 5px 30px; font-size:14px; text-decoration:none; background-image: url(images/printer.png); background-repeat: no-repeat; background-position: 7px 50%; -moz-border-radius: 5px; -webkit-border-radius: 5px; } .print-button a:hover { background-color:black; } .theNote .content { width: 8.0in !important; margin: 5px auto; padding:20px; background-color:white; } .theNote .header { border-bottom: 1px dashed #C8C8C8; font-size: 17px; padding: 0 0 10px; line-height: 19px; color: #00ADE1; min-width:500px; } .theNote .body { font-size: 14px; line-height: 19px; padding: 10px 0; } .theNote{ padding:6px 0; clear:both; background-color: rgb(200,200,200); } .theNote h3{ color: rgb(100,100,100); } .theNote h1, .theNote h3{ background-color:white; padding:2px 20px; width:8.0in !important; margin: 0 auto; font-size: 15px; } .theNote h1{ padding-top: 10px; font-size: 15px; } .theNote h1:first-child{ font-size: 20px; } .theNote h3 { font-size: 14px; font-weight: normal; } #options { border: 3px double #ccc; padding: 5px 12px; margin: 10px 50px 10px 20px; float: left; } #info { border-top: 1px solid #ccc; padding-top: 5px; font-style: italic; } li { margin: 5px 10px 5px 25px; } ul li { list-style: disc; } ol li { list-style: decimal; } img { border: 0; } table { clear: both; width: 100%; border: 1px solid #c5c5c5; border-width: 1px 0; margin: 0; page-break-after: always; } table#page { page-break-after: auto; } td { text-align: center; font-size: 12px; border-bottom: 1px dashed #c5c5c5; height: 1.75in; width: 50%; padding-left: 15px; } .leftside { border-right: 1px solid #cccccc; padding: 0 15px 0 0; } .bottom td { border-bottom: none; } .clearfix { clear:both; line-height:1px; height:1px; } img { max-width:80%; max-height:150px; margin:20px; } @media print {.header { display: none; } .content .header{ display:inherit; } table { border: 1px dashed #bbb; border-width: 1px 0; } .theNote{ background-color:white; } } Final Terms Chapter 1 What is Economics? Social science that studies the choices that individuals, businesses, governments, and societies make as they cope with scarcity and the incentives that influence and reconcile those choices. What is Macroeconomics? The study of the performance of the national and global economy. Marginal Benefit- The benefit that arises from an increase in an activity. Marginal Cost- The cost of an increase in an activity. Opportunity Cost- The highest valued alternative. Economic Model- A description of some aspect of the world that includes only those features that are needed for the purpose at hand. Natural Experiment- One factor of interest is different and all other things are equal/similar. Statistical Investigation- Correlation experiment. Economic Experiment- Puts people in a decision-making situation and varies the influence of one factor at a time to discover how they respond. Choosing at the Margin- Evaluate the consequences of making incremental changes in the use of resources. Chapter 2 Production Possibilities Frontier (PPF)- The boundary between the combinations of goods and services that can be produced and those that cannot. Opportunity Cost- (Decrease in Production of one Good) ÷ (Increase in Production of Another Good) Productive Efficiency- Points on the PPF, the goods and services are produced at the lowest possible cost. Allocative Efficiency- When goods and services are produced at the lowest possible cost and in the quantities that provide the greatest possible benefit. Economic Growth and the PPF 1. shifts the PPF outward 2. occurs when production expands 3. caused by technological change and capital accumulation Gains from Trade- Created by specialization according to comparative advantage and trading because it allows consumption along the trade line at points outside the PPF. Markets- Any arrangement that allows buyers and sellers to do business with each other. Prices- Created by pools of information that signals buyers and sellers about the actions they should take. Chapter 3 The Law of Demand- Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded. The Demand Curve- Shows the relationship between the price of a good and the quantity demanded. Substitution Effect- A higher relative price raises the opportunity cost of buying a good and so the quantity demanded decreases. Income Effect- Price of a good rises relative to income, people cannot afford all the things they previously bought, so quantity demanded decreases. Factors that Influence Demand Price of Related Goods Expected Future Prices Income Expected Future Income and Credit Population Preferences Shifts Demand Curve Leftward- Decrease in Demand Shifts Demand Curve Rightward- Increase in Demand Law of Supply- The higher the price, the greater the quantity supplied. Factors that Influence Supply Prices of Factors of Production Prices of Related Goods Produced Expected Future Prices Number of Suppliers Technology State of Nature Supply Curve- Shows the relationship between the quantity supplied and the price. Equilibrium Price- Price at which quantity demanded equals the quantity supplied. Equilibrium Quantity- Quantity bought and sold at the equilibrium price. Increase in Demand Increase in Price Increase in Quantity Decrease in Demand Decrease in Price Decrease in Quantity Increase in Supply Decrease in Price Increase in Quantity Decrease in Supply Increase in Price Decrease in Quantity Chapter 4 Gross Domestic Product (GDP)- Market value of all final goods and services produced in a country. Expenditure Method- Y = C + I + G + X - M Income Method - Y = W + i + R + Profit Real GDP per Person -Real GDP divided by the population Potential GDP - Quantity of real GDP when in full employment. Business Cycle -Periodic but irregular movement of total production and other measures of economic activity 4 Parts to the Definition of GDP- Market value, Final goods and services, Produced within a country, In a given time period Chapter 5 Frictional Unemployment - Arises from normal labor market turnover. Raises when there are increases in the number of people entering and reentering labor force and unemployment compensation. Structural Unemployment - Created by changes in technology and foreign competition that change the skills needed to perform jobs or locations of jobs. Cyclical Unemployment - Fluctuating unemployment over the business cycle. Natural Unemployment - Always someone without a job who is searching for one; always some unemployment. Unemployment Rate - Percentage of the labor force that is unemployed. (# of unemployed ÷ labor force) x100 Labor-Force Participation Rate - Percentage of Working-Age population who are members of the Labor Force. (Labor Force ÷ Working-Age Population) x100 Sources of Unemployment - Loss of job and search for new one - Leave their job and search for new one - Enter or reenter the labor force to search Inflation Rate - Annual percentage change of the price level. Consumer Price Index (CPI) - Measures the average price paid by urban consumers. Calculate the CPI - (Cost of CPI basket at current period) ÷ (Cost of CPI basket at base-period) x100 CPI Biases - New Goods Bias - Quality Change - Commodity Substitution - Outlet Substitution GDP Deflator - Deflate nominal values to find their real values. (Nominal GDP ÷ Real GDP) x100 Chapter 6 Economic Growth Rate - Annual percentage change of real GDP. Rule of 70 - The number of years it takes for the level of any variable to double is approximately 70 divided by the annual percentage growth rate of the variable. What is the average economic growth rate of the U.S.? - 2% Labor Productivity - The quantity of real GDP produced by an hour of labor. What causes Potential GDP to grow?- When the supply of labor or labor productivity grows. What increases labor productivity growth? - Increases in capital - Increases in technology Classical Growth Theory - Real GDP growth is temporary and when real GDP/person rises above the subsistence level, a population explosion eventually brings real GDP/person back to the subsistence level. (However, population growth is not tightly linked to income per person) Neoclassical Growth Theory - Real GDP/person grows because technological changes increase saving and investment so that the capital stock grows. Unless technology keeps advancing, economic growth ceases. New Growth Theory - Real GDP/person grows because of the choices people make in the pursuit of profit and growth will persist indefinitely. Chapter 7 Finance -The funds used for investment in physical capital. Money -What is used to buy goods and services. Physical Capital- The actual tools, instruments, machines, buildings, and other items constructed in the past and used to produce goods and services. Financial Capital- The funds firms use to buy and operate physical capital. Depreciation- The decrease in the capital stock because of wear and tear and obsolescence. Gross Investment- The total amount spent on new capital. Net Investment- The change in the value of the capital stock. Gross investment - Depreciation. Financial Markets -Promote economic efficiency by producing an efficient allocation of capital, which increases production. Enable firms and households to transfer money back and forward in time to match desired spending patterns. Interest Rate- Interest received expressed as a percentage of the price of the asset. Nominal Interest Rate- The number of dollars a borrower pays and a lender receives in interest in a year expressed as a percentage of the loan. Real Interest Rate- The nominal interest rate adjusted to remove the effects of inflation on the buying power of money. (Nominal Interest Rate) - (Inflation Rate) Market for Loanable Funds- Aggregate of all the individual financial markets. What mainly makes up demand for loanable funds? Business investment What decreases the quantity demanded for loanable funds? Increase in the interest rate. What increases the supply of loanable funds? Increase in saving. What determines the real interest rate? The demand for loanable funds and the supply of loanable funds. What increases the real interest rate? When the demand for loanable funds increase. What decreases the real interest rate? The supply of loanable funds increases. How are financial markets in the short-run? Volatile How are financial markets in the long-run? Stable What are the effects of a budget deficit? Increase in the demand for loanable funds, increase in saving, and decrease in investment. What are the effects of a budget surplus? An increase in the supply of loanable funds. What is the crowding-out effect? The tendency for a government budget deficit to raise the real interest and decrease investment. Chapter 8 Money- Any commodity or token that is generally acceptable as a means of payment. How is money a medium of exchange? It is generally accepted in exchange for goods and services. How is money a unit of account? It is an agreed measure for stating the prices of goods and services. How is money a store of value? It can be held and exchanged later for goods and services. What does M1 consist of? Currency and traveler's checks plus checking deposits owned by individuals and businesses. What does M2 consist of? M1 plus time deposits, savings deposits, and money market mutual funds and other deposits. Depository Institution- A financial firm that takes deposits from households and firms and makes loans to other households and banks. What are the four economic services of depository institutions? 1) Create liquidity 2) Pool Risk 3) Lower the cost of obtaining funds 4) Lower the cost of monitoring borrowers What is the Federal Reserve System? The central bank for the U.S. that regulates the nation's depository institutions and controls the quantity of money. Board of Governors- 7 members appointed by the President and confirmed by the Senate for 14 year terms. It oversees the operations of the FED. Regional Federal Reserve Banks- 12 regional banks, each of which has a president Federal Open Market Committee- The main-policy making group. Monetary Base- The sum of Federal Reserve notes, coins, and depository institution's deposits at the Fed. What are the 3 functions of the Federal Reserve System? 1) Required Reserve Ratio 2) Lender of Last Resort 3) Open Market Operations How do banks create money? Making loans! Banks have excess reserves so they create new deposits. The quantity of money increases and the new money is used to make payments. Some of the new money remains on deposit and some of the money is a currency drain. There is an increase in desired reserves which causes a decrease in excess reserves, but the reserves stay positive. What influences the demand for money? 1) The price level 2) Nominal Interest Rate 3) Real GDP 4) Financial Innovation What is the Quantity Theory of Money? In the long run, an increase in the quantity of money brings an equal percentage increase in the price level. Chapter 9 What is a currency exchange rate? The price at which one currency is exchanged for another to buy goods and services produced in that country. What is the exports effect? The larger the value of U.S. exports, the greater the quantity of U.S. dollars demanded. What is the expected profit effect? The larger the expected profit from holding U.S. dollars, the greater quantity of U.S. dollars demanded. What is the imports effect? The larger the value of U.S. imports, the larger the quantity of U.S. dollars supplied. How does the expected profit affect the supply of U.S. dollars? The higher the current exchange rate, the greater the profit from buying foreign currency, the greater is the quantity of U.S. dollars supplied. What is the interest-rate parity? "Equal rates of return", the exchange rate adjusts so that the return from investing in assets in different nations is the same. The exchange rate adjusts immediately so that interest rate parity always holds. What is the purchasing power parity? "equal value of money", the exchange rate adjusts so that one currency can buy the same amount of goods and services as another currency. (Holds in the long run) What is the equation for the nominal exchange rate? E = RER x (P* / P) What is the equation for the real exchange rate? RER = E x (P / P*) What is the current account? Records receipts for exports, payments for imports, net interest, and net transfers. (Exports - Imports) + Net Interest + Net Transfers What is the capital account? Records foreign investment in the U.S. and U.S. investment abroad. What is the Official Settlements Account? Shows changes in U.S. official reserves (government holdings of foreign currency). How does the balance of payments finance international trade? It records a country's international trading, borrowing, and lending into 3 accounts and makes sure the accounts must always sum to zero. Flexible exchange rate - is one that permits the exchange rate to be determined by demand and supply with no direct intervention in the foreign exchange market by the central bank. Fixed Exchange rate - is one that pegs the exchange rate at a value decided by the government or central bank and that blocks the unregulated force of demand and supply by direct intervention in the foreign exchange market. Crawling peg exchange rate policy - is one that selects a target for the exchange rate that changes periodically, with intervention in the foreign exchange market to achieve the target. Chapter 10 What is Aggregate Supply? The relationship between the quantity of real GDP supplied and the price level. What is Aggregate Demand? The relationship between the quantity of real GDP demanded and the price level. Short-Run Macroeconomic Equilibrium- The quantity of real GDP demanded equals the quantity of real GDP supplied. Long-Run Macroeconomic Equilibrium: Real GDP = Potential GDP Recessionary Gap- The amount by which potential GDP exceeds real GDP. Inflationary Gap- The amount by which real GDP exceeds potential GDP. Classical Theory- The economy is self-regulating and always at full employment. Real GDP always equals Potential GDP. Classical macroeconomists recommend polices that have distinctive effects of taxes on employment investment and technological change. Keynesian Theory- To achieve full employment in an economy, active help from fiscal policy and monetary policy is needed. Aggregate demand fluctuations and sticky money wages lead to business cycle. Defining feature is that economy is rarely at full employment. Recommend policies that actively offset changes in aggregate demand that bring recession. Keynesian cycle theory - animal spirits are the main source of fluctuations in aggregate demand. Monetarist Theory- The economy is self-regulating and it will normally operate at full employment provided that monetary policy is not erratic and the pace of the money growth is kept steady. Recommend polices that keep taxes low to avoid disincentive effects that decrease potential GDP. Monetarist cycle theory - fluctuations in both investment and consumption expenditure driven by fluctuations in the growth Chapter 11 What happens to aggregate expenditure when real GDP increases? Aggregate Expenditure increases. Consumption Function- The relationship between consumption expenditure and disposable income. Marginal Propensity to Consume (MPC)- The fraction of a change in disposable income that is consumed. Calculated by the change in consumption expenditure divided by the change in disposable income. What is the slope of the consumption function? The marginal propensity to consume Saving Function- The relationship between saving and disposable income. Marginal Propensity to Save- The fraction of a change in disposable income that is saved. Autonomous Expenditure- The sum of the components of aggregate expenditure that do not change when real GDP changes. Equilibrium Aggregate Expenditure- The level of aggregate expenditure when aggregate planned expenditure equals real GDP. Where the AE curve intersects 45 line the lvl of aggregate expenditure that occurs is equilibrium expenditure. The Autonomous Expenditure Multiplier- The amount by which a change in autonomous expenditure is multiplied to determine the change in equilibrium expenditure and real GDP. Business Cycle Expansion- When autonomous expenditure increases and the multiplier effect increase equilibrium expenditure. Business Cycle Recession- When autonomous expenditure decreases and the multiplier effect decreases equilibrium expenditure. Chapter 12 Demand-Pull Inflation- Inflation that starts from an initial increase in aggregate demand. Cost-Push Inflation- Inflation that starts from the result of an increase in costs. Phillips Curve- Shows a relationship between inflation rate and unemployment rate. Short Run Phillips Curve- Holds the expected inflation rate and the natural unemployment rate constant. Long Run Phillips Curve- Actual Inflation Rate = Expected Inflation Rate Mainstream Theory- The business cycle is a result of aggregate demand growth fluctuating around steadily growing potential GDP. The money wage rate is sticky Real Business Cycle Theory- Random fluctuations in productivity are the main source of economic fluctuations. The source of the business cycle is fluctuations in productivity which results mainly from fluctuations in the pace of technological change. Chapter Thirteen: Fiscal Policy The Federal Budge t: used to achieve macroeconomic objectives; tax revenues can exceed, equal, or fall short of outlays- the budget can be in surplus, balanced, or in deficit; deficits in budget create debt. Supply-Side Effects of FIscal Policy : has side effects because taxes weaken the incentive to work, and decrease employment and pGDP; U.S. labor tax wedge is large, but small compared to those of other industrial countries; taxes weaken the incentive to save and invest, which lowers the growth rate of rGDP. Generational Effects of FIscal Policy : a major 2003 study estimated the U.S. fiscal imbalance to be $45 trillion- four times the value of one year's production; future generations will pay for 57% of the benifits of the current generation; about half of U.S. government debt is held by the rest of the world. Stabalizing the Business Cyle : fiscal stabilization can be discretionary or automatic; discretionary changes in government expenditure or taxes can change aggreagate demand but are hampered by law-making lags and the difficulty of correctly diagnosing and forecasting the state of the economy; automatic changes in fiscal policy moderate the busness cycle Chapter Fourteen: Monetary Policy Monetary Policy Objectives and Framework : the goal of table prices delivers maximum employment and low interest rates int he long run but can conflict with the other goals in the short run; the Fed translates the goal of stable prices as an inflation rater of between 1 and 2 percent per year. The Conduct of Monetary Policy : the Fed's monetary policy instrument is the federal funds rate; the Fed sets the federal funds rate target and announces changes on eight dates each year; the Fed hits its federal funds rate target by using open market operations; by buying or selling government securities in the open market, the Fed is able to change bank reserves and change the federal funds rate. Monetary Policy Transmission : a cahgne in the federal funds rate changes other interest rates, the exhcnage rate, the quanitty of money and loans, aggregate demand, and eventually rGDP and the price level; changes int he federal funds rate change rGDP about one year later and change the inflation rate with an even longer time lag. Alternative Monetary Policy Strategies : main alternative to setting the federal funds rate are monetary base instument rule, a money targeting rule, an exchange rate targeting rule, or an inflation rate targeting rule; rules trump discretion in monetary policy because they better enable the central bank to manage inflaition expectations.