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INTRO TO MACROECON Study Guide -- I 4.0ed the final exam!

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Intro Macro - Sheflin Essential Questions in Intro Macroeconomics 12/2013 (NOTE, we have not covered some of these topics yet, but will by the end of the semester) Many/most Final Exam multiple-choice questions will deal with these issues (as did the HW assignments in one form or another). If you can answer these in words, you should have no trouble with the multiple choice questions on the final. If you cannot, look up the answers and if still having trouble, post on the FINAL EXAM RELATED chat room. See the REVIEW GUIDE for more information and suggestions on how to study. Graph means show the appropriate graphical analysis –ex: aggregate Supply and Demand, Money Supply and Demand, Yield Curve, etc.Arrow diagram means be able to trace out steps - MiIDP,Y Equation means be able to write out a related equation - Y=C+I+G+X-M YOU SHOULD LIKELY STUDYTHIS FROM THE BOTTOM TO THE TOP – THAT IS, FROM MATERIAL COVERED LATE IN THE COURSE, BACK TO THE BEGINNING. Items in italics will most likely NOT be on the exam BACKGROUND AND MICRO ISSUES 1. How do economists measure the value of anything? • By its market price determined by supply (reflecting costs and scarcity) and demand (reflecting tastes) 2. What determines the price and quantity of any good or service? • The demand curve; a change in demand means the whole curve shifts, due to a change in income, tastes, or the prices of other relevant goods 3. What is opportunity cost and why is there no free lunch? • Opportunity cost – the cost of an alternative that must be forgone in  order to pursue a certain action; or the benefits you could have  received by taking an alternative action • No free lunch – commonly used to describe situations in which  investors are not able to consistently make large profits without  bearing the risk of a potential loss 4. What does the invisible hand mean, and why does it suggest laissez-faire? • Basis for belief in “free-market” capitalism in which individual self- interest, coming together in a competitive market place, leads to a socially efficient outcome as though “guided by the invisible hand of providence” 5. What are the three questions answered by any economic system and how are they answered under a market-based system • What will be produced? How will it be produced? For whom will it be produced? 6. What is the difference between capitalism, socialism, communism • Capitalism – economic system based on private ownership of capital • Socialism – economic system based on state ownership of capital • Communism – abolishes private ownership 7. What is the definition of Microeconomics? Macroeconomics? Economics? • Microeconomics – the study of decisions that people and businesses make regarding the allocation of resources and prices of goods and services • Macroeconomics – studies the behavior of the economy as a whole and not just on specific companies, but entire industries and economies • Economics – branch of social science that deals with the production and distribution and consumption of goods and services and their management CIRCULAR FLOW, NATIONAL INCOMEACCOUNTINGAND OTHER MEASUREMENTS 1. 2 Important points of the Circular flow model • The equivalence of real and money flows • The equality of production and income, and savings = investments 2. Define GDP (precisely) • 5 components: domestically produced, final good, services, gross, C+I+G+NX 3. 3 Ways to calculate GDP (ValueAdded is one) • 2 loops of circular flow model • GDP= C+I+G+NX • Nominal GDP= Real GDP(P) 4. What is the relation between Gross and Net Investment and Depreciation • Net investment = Gross Depreciation • Net investment = Gross investment - depreciation 5. Definition of Real and Nominal GDP • Real GDP– level of GDPafter changes in inflation have been taken into account • Nominal GDP– calculated at existing prices 6. How do you calculate real GDP from nominal? Formula • Nominal GDP= Real GDP(P) 7. What is meant by deflating nominal GDP? • Calculating Q from PQ 8. How do we measure/calculate unemployment, labor force, employment? • Surveys 9. What are Discouraged Workers and Hidden Unemployment • Discouraged workers – those who gave up on their job hunt, a part of hidden unemployment 10. What is the CPI? What is it used for? • Consumer price index – an index of the cost of all goods and services to a typical consumer 11. How is the CPI calculated, very roughly (in a sentence)? • r = Pn/Pe 12. What are shortcomings of the CPI? • Overstates the cost of living because it doesn’t reflect increases in quality, or an allowance for the substitution of goods 13. Why do economists prefer the chained CPI? • Provides a more accurate measure of the average change in the cost of  living than the standard CPI 14. What is the GDP deflator? • Nominal/Real x 100 15. What is meant by chained ($2005) GDP? • Real GDP 16. What is meant by seasonally adjusted data? • Astatistical adjustment made to accommodate predictable fluctuations as a function of the season of the year 17. What are some shortcomings of GDP as measure of economic activity and well being? • Does not take into account nonmarket transactions, fails to account for improved product quality, underground economy not included INVESTMENT RELATED 1. What is the economic role of the financial system – what useful purpose does it serve for the overall economy? • Provision of liquidity, credit provision, risk management 2. What is Stock? • Atype of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings (shares of a company) 3. What is the major reason people buy stock? • High reward, to make money/capital 4. What is leverage, liquidity, buying on margin, selling short? • Leverage – use of debt to supplement investment • Liquidity – The ability to be easily redeemed for a value • Buying on margin – buying securities on credit • Selling short – selling assets, usually securities, that have been borrowed 5. What are the roles of dividends and the risk-adjusted discount rate in determining the fundamental price of a stock (Stock Price=Dividends/(risk adjusted discount rate dividend growth rate)? • Determine what a stocks price should be using the stream of constant dividends and risk adjusted discount rate (P=n/r) 6. What is a speculative bubble? • Aspike in asset values within a particular industry, commodity, or asset class.Aspeculative bubble is usually caused by exaggerated expectations of future growth, price appreciation, or other events that could cause an increase in asset values 7. How do stocks compare to bonds? • Stocks tend to have a greater risk for the return, and a higher reward. Bonds tend to be more stable than stocks (fixed rate of return year round) 8. How and why should you invest in stocks? • By investing your money, you are getting your money to generate more money by earning interest on what you put away or by buying and selling assets that increase in value 9. What is the advantage of diversification? • Risk reduction, capital preservation, ability to hedge your portfolio – LESS RISK 10. What is the efficient markets hypothesis, and how does it relate to random walks? • EMH – An investment theory that states it is impossible to "beat the  market" because stock market efficiency causes existing share prices  to always incorporate and reflect all relevant information • Random walks – past movement or trend of a stock price or market  cannot be used to predict its future movement 11. What are Bonds? Bond Ratings, Junk Bonds, Treasury Bonds, Corporate Bonds, Muni/S&L Bonds? • Bonds – A debt security, similar to an IOU • Bond ratings – bond quality/credibility • Junk bonds – a bond rate “BB” or lower because of its high default  risk • Treasury bonds – government issued debt • Corporate bonds – bond issued by a corporation • Municipal/S&L bonds – interest income is exempt from federal  income tax 12. What are Mutual Funds? • Acollection of both stocks and bonds 13. What is a hedge fund? An ETF? • Hedge fund – An aggressively managed portfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns • ETF – Asecurity that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold 14. What is a stock index mutual fund, and why should you likely use it for long-run investing? • A type of mutual fund with a portfolio constructed to match or track  the components of a market index, such as the Standard & Poor's 500  Index (S&P 500); low operating expenses 15. What is a 401k? What should be in it? • Employees may make salary deferral (salary reduction) contributions on a post-tax and/or pretax basis (saving for retirement) 16. What are derivatives? • Asecurity whose price is dependent upon or derived from one or more underlying assets; the derivative itself is merely a contract between  two or more parties 17. What’s an option? Afutures contract?Acall option? • Option – right to buy or sell • Futures Contract – contract to buy or sell a specified commodity of standardized quality at a certain date in the future and at a market- determined price • Call Option – the option to buy a given stock at a given price before a given date 18. What’s an IPO? • Initial Public Offering – The first sale of stock by a private company to the public 19. What are primary and secondary financial markets? • Primary market – where new securities are created; new stocks and bonds are sold to the public for the first time • Secondary market – what people are talking about when they refer to the "stock market.” Ex: NYSE, Nasdaq 20. What are financial intermediaries? • An entity that acts as the middleman between two parties in a financial transaction. Ex: commercial bank, investment back, insurance companies MONEYAND THE FED 1. What is Money? Wealth? Income? How are they different? • Money – the circulating medium of exchange as defined by a government • Wealth – a measure of the value of all of the assets of worth owned by a person, community, company or country • Income – Money that an individual or business receives in exchange for providing a good or service or through investing capital 2. Define M1, M2 • M1 – currency (coins and bills), checkable deposits, and travelers checks (all of which are used in exchange) – most liquid • M2 – checking account deposits and savings account deposits 3. What are the three functions of money? • Medium of exchange, unit of account, and store of value 4. Why are the advantages of an economy using money rather than barter? • Lowers transaction and info costs, allows specialization in labor, and develops financial system 5. What is barter and what are the shortcomings of barter? • Goods for goods (without money) • Shortcomings: inefficient, high transaction costs 6. What is the Fed? Describe its structure. Why does the Fed have the structure it does (12 banks, etc). • The Federal Reserve • Considerable independence – created by Congress, can be changed by  them  • Board of Governors, fed open market committee, federal reserve  banks, member banks, advisory councils; 12 banks divide nations into  12 districts 7. What are the goals, tools/instruments, and targets of the Fed? • Goals – price stability/control inflation • Tools – open market operations, discount rate, reserve • Targets – federal funds rate 8. Explain in words how a Fed open market purchase increases the money supply • The government securities that are used in open market operations are treasury bills, bonds, and notes. If the FOMC (Federal Open Market Committee) wants to increase the money supply in the economy, it will buy securities. Conversely, if the FOMC wants to decrease the money supply, it will sell securities. 9. What is the operating target of the Fed? • Federal Funds Rate: the Fed picks a target r, the Fed fund rate that is thought to be consistent with their goals and uses open market purchases or sales to ‘nudge’the actual funds to the target value 10. What is the primary ‘traditional’policy tool of the Fed? • Open market operations – purchase and/or sales of outstanding government bonds from private bond dealers; also discount rate which tends to passively follow funds rate and control of reserve requirements – not used. 11. What are the ultimate goals of the Fed? • They have two - Dual mandate • Stable prices and maximum employment in that order (moderate long-run rates follow from these, and many believe the maximum employment in the long-run follows from price stability) 12. What is the Taylor Rule? • The Fed increases interest rates in times of high inflation, or when employment is above the full employment levels, and decreases interest rates in the opposite situations 13. What is inflation targeting? • Central banking policy that revolves around meeting preset, publicly displayed targets for the annual rate of inflation. Ex: CPI 14. Is the Fed Independent? Why? How? (more on the Fed below) • Yes – not owned; not a private profit-making institution 15. What is quantitative easing? • Even in liquidity trap, Fed might be effective by increasing MS and causing some inflation, and easing credit conditions 16. Why is Fed credibility important? • The Fed's credibility regarding control of inflation helps to anchor public expectations of price stability. This makes the Fed's actions more predictable in any given set of circumstances and strengthens the monetary policy transmission mechanism and shortens policy lags. SHORT RUN KEYNESIAN MODEL(all of the following refer to the Keynesian model and the short-run only) 1. What determines aggregate prices and output? • Aggregate demand / aggregate supply 2. What determines interest rates? • Money demand / money supply  nominal interest 3. What are the components of aggregate demand? • Aggregate D = C+I+G+NX (NX=net exports=imports-exports) 4. Why is the aggregate demand curve downward sloping? (not so important) • Interest rate effect, real balance effect, foreign purchases effect 5. What are the determinants of: • *Consumption – Y-T, wealth • Saving – Y-T, wealth • *Investment – interest rates • Government Expenditures – exogenous • Exports – foreign income • Imports – US income 6. What are the condition(s) for equilibrium? • Occurs when agg demand = agg supply (Y=C+I+G+X-M) • Unintended inventories = 0,AD=AS=Y, I=S 7. What is the role of inventories? • Inventory change – part investment; unintended – demand slowing, intended – business is good 8. What factors shift the aggregate demand curve? The aggregate supply curve? • Agg Demand Curve shifts – any changes in C, I, G, X-M • Agg Supply Curve shifts – costs of production: wages, raw materials, technology/productivity 9. How does the stock market affect the economy? • Significantly adds to the wealth effect – if people feel wealthier, consumption increases 10. What are the ‘types’of unemployment? • Structural unemployment – mismatch between skilled workers and employers’needs • Frictional unemployment – moving from one job to another (time in between) • Cyclical unemployment – demand deficient, not enough demand 11. What is inflation and what causes it in the short-run? • Inflation is a sustained increase in general price level • Causes in SR: increase in money supply 12. What is the short-run Phillips curve and why is it important? • The Phillips Curve cannot be stable in the short run • Inverse relationship between unemployment and inflation; If inflation is high, then unemployment is low 13. What is 45-degree line (Keynesian cross) analysis? (You do not have to know how to ‘do it’just what it is and what it is used for). • Illustrates whether consumption spending is equal to, greater than, or less than the level of disposable income 14. What causes business cycles, and what are they? • Business Cycles – Periodic, irregular ups and downs in economic activity, such as expansions & contractions (recessions, depressions) and peaks & troughs • Caused by demand or supply shocks 15. How does monetary policy impact the economy in the short-run? • SR: stabilizes business cycles and affects potential and real GDP • LR: affects prices 16. Which is the shorter and which the longer lag in monetary policy? • Shorter: implementation lag • Longer: impact lag 17. How does fiscal policy impact the economy? • Governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn, curbs inflation, increases employment, and maintains a healthy value of money 18. What is the effect of a government budget deficit? • Have to pay interest on loans  less for investment  hinders economic growth 19. Which is the shorter and which the longer lag in fiscal policy? • Shorter: impact lag • Longer: implementation lag 20. What is the idea of the political business cycle? • Changes in the economy as a result of political tactics before and after elections. To gain voter support politicians will often expand the economy prior to elections and implement reforms just after the elections 21. What is a consumption function? The mpc? the multiplier? • C = F(Y-T,W) • Expenditure multiplier = 1/(1-MPC) • Ex: If C=100+0.9Y, MPC=0.9, Multiplier=1/(1-0.9)=10 22. Calculate the Government Expenditure multiplier formula • 1 / (1-mpc)  where mpc is the marginal propensity to consume, and indicates the change in consumption resulting from a 1 change in income 23. What is the paradox of thrift? • The notion that individual savings (rather than spending) can worsen a recession; individual saving is collectively harmful • Consumer spending contributes to the collective good, because one person's spending is another person's income 24. What is the wealth effect? • Changes in wealth will impact Consumption and Aggregate Demand  higher wealth, increase spending LONG –RUN CLASSICAL MODEL (each of the following refers to the Classical Model) 1. What determines output? • Labor, full employment 2. What determines prices? • Money supply 3. What determines interest rates? • Savings and Investment  real I; nominal I = real I + inflation 4. What is loanable funds theory? • (Neo classical) – the rate of interest is the price that equates the demand for and supply of loanable funds • In other words: *the real interest rate is determined by savings (S) and investment (I); S will equal I (according to Say’s Law) 5. What is Say’s law? • "Supply creates its own demand" - hence no unemployment (other than structural and frictional). 6. What is the quantity theory? • States that there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold (MV=Py) 7. What is the natural rate of unemployment (NAIRU)? • The equilibrium rate of unemployment; verticalAS curve 8. What is the relation between the nominal and real interest rates and inflation? Formula • i rea
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