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Term Test 2 Study Guide!

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ECON 1132
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Macroeconomics Exam 2 Review Chapter 12: Inflation and the Quantity Theory of Money Inflation – an increase in the general or average level of prices Inflation rate – the percentage change in the average level of prices over a period of time Inflation rate = (P2-P1)/P1 GDP deflator – measures the average price of all final goods and services GDP deflator: PPI – measures the average price received by producers Consumer price index (CPI) – measures the average price of goods bought by a typical American consumer Real Price – A price that has been corrected for inflation; used to compare the prices of goods over time Hyperinflation – extremely high rates of inflation that make inflation in the U.S. look pretty tame by comparison Money has three purposes: - It is a store of value (transfers purchasing power from the present to the future) - It is a unit of account (numeraire) - It is a medium of exchange (what we use to buy goods and services) Velocity of money – the average number of times a dollar is spent on final gods and services in a year Quantity Theory of Money: Mv = PY Where M = money supply, V = Velocity, P = Price Level, y = Real output Deflation – a decrease in the average level of prices (a negative inflation rate) Disinflation – a reduction in the inflation rate Price confusion – inflation makes price signals more difficult to interpret. Money Illusion – The false perception that occurs when people mistake changes in nominal prices for changes in real prices Nominal Rate of Return – The rate of return that does not account for inflation Real Rate of Return – The nominal rate of return minus the inflation rate rreal i – p Where: r real real rate of return, i = nominal rate of interest, p = rate of inflation i = π + r equilibrium Fisher effect – The tendency of nominal interest rates to rise one to one with expected inflation rates Fisher formula Monetizing the debt - the result of government paying off its debts by printing money Chapter 14: Transmission and Amplification Mechanisms Transmission mechanisms – economic forces that can amplify the impact of shocks on the economy Intertemporal substitution – the allocation of consumption, work and leisure across time to maximize well-being Irreversible investments – investments that cannot be easily moved, adjusted or reversed if conditions change Labor adjustment costs – the costs of shifting workers from declining sectors of the economy to growing sectors Time bunching – the tendency for economic activities to be coordinated at common points in time Collateral – something of value that by agreement becomes the property of the lender if the borrower defaults Collateral shock – a reduction in the value of collateral. Collateral shocks make borrowing and lending more difficult Aggregate Expenditure Slides: Understanding Business Fluctuations Consumption Function: C = C0 + α X Y The slope of the line (α) is the MARGINAL PROPENSITY TO CONSUME (MPC): the percentage of each dollar spent on consumption goods by households Y = C + I + G + NX MULTIPLIER = 1/(1-MPC) (In our example, MPC = 0.7, so the multiplier is 3.34. If investment increases by 30, Y increases by 30 x 3.34=100) Change in Taxes: ΔY = -ΔT (α/(1 – α)) Change in Government Spending: ΔY = ΔG (1/(1 – α)) IM = IM0 + β X (Y-T) When β = Disposable income Closed Economy: ΔY = ΔI x 1/(1 – α) Open Economy: ΔY = ΔI x 1/(1 – α + β) The open economy multiplier is smaller than the closed one Marginal Propensity to Save (MPS): (1- α) Aggregate Demand and Aggregate Supply Changes in Price levels are movements along the aggregate demand curve Shifts in the AD are called demand shocks Changes in Consumption, Investment, Government Spending, and Net Exports shift the aggregate demand Increases in Consumption, Wealth, and Investment shift AD to the right If consumers become more optimistic the AD shifts to the right If government spending increases then the AD shifts to the right If taxes increase then the AD shifts to the left If Money Supply increases, then AD shifts to the right Only Real Shocks have an impact on the LRAS Changes in technology, population, natural resources shifts the LRAS Supply of money does not change LRAS The SRAS shifts when the costs of production change The OUTPUT GAP is the difference (in percentage terms) between
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