Study Guide ECON 104 Final

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Questions and Answers

What are the tools of monetary policy?

Open Market Operations, Discount Rate, Reserve Requirements.

What is the meaning of aggregate supply (AS)?

It is the total quantity of goods and services that producers in an economy are willing and able to supply at different price levels.

What is the AS curve?

It shows how much goods and services firms are willing to produce at different price levels in the short run.

What factors shift the AS curve?

Changes in the quantity and quality of labor, stock of capital, and improvements in technology. Signup and view all the answers

What is the meaning of aggregate demand (AD)?

It is the total quantity of goods and services demanded across the economy at different price levels. Signup and view all the answers

What is the relationship between the interest rate (r) and aggregate output (Y)?

Higher interest rates reduce investment and consumption, leading to lower aggregate output. Signup and view all the answers

What happens in the AD/AS model when the economy is at short-run equilibrium?

It occurs where the AD curve intersects the SRAS curve. Signup and view all the answers

What are the effects of fiscal policy?

It involves government decisions on spending and taxation to influence the economy. Signup and view all the answers

What are the effects of monetary policy?

It involves the central bank’s actions to control the money supply and interest rates. Signup and view all the answers

What is the balance of payment systems?

It includes the Current Account, Financial Account, and Capital Account. Signup and view all the answers

What is the foreign exchange market?

It is where currencies are traded to facilitate international trade. Signup and view all the answers

What is currency appreciation?

When a country’s currency becomes stronger relative to other currencies. Signup and view all the answers

What is currency depreciation?

When a country’s currency becomes weaker relative to other currencies. Signup and view all the answers

What is GDP?

GDP is the total value of all final goods and services produced within a country during a specific time period. Signup and view all the answers

What is the GDP calculation formula?

GDP = C + I + G + NX Signup and view all the answers

What is the difference between nominal GDP and real GDP?

Nominal GDP changes with prices and does not adjust for inflation, while real GDP adjusts for inflation. Signup and view all the answers

Who is considered unemployed in employment surveys?

Unemployed people are those who don’t have a job but are actively looking for one and are ready to work. Signup and view all the answers

What are the three types of unemployment?

Frictional, Structural, and Cyclical Unemployment. Signup and view all the answers

What is the natural rate of unemployment?

The natural rate of unemployment is the level of unemployment that happens even when the economy is doing well. Signup and view all the answers

What is inflation?

Inflation is the increase in the general price level of goods and services over time. Signup and view all the answers

What are considered automatic stabilizers?

Progressive Taxes Signup and view all the answers

What is the multiplier effect?

The multiplier effect shows how an initial change in spending leads to a larger change in real GDP. Signup and view all the answers

What are some functions of money?

Medium of Exchange Signup and view all the answers

What is a barter system?

A barter system is where goods and services are exchanged directly for other goods and services without using money. Signup and view all the answers

What are the qualities that make something suitable for use as money?

Widely accepted, standardized quality, durable, portable, and divisible. Signup and view all the answers

What is the money multiplier?

The money multiplier is the ratio of the amount of money created by the banking system to the number of reserves. Signup and view all the answers

Fiscal policy only involves changing government spending.

False Signup and view all the answers

What is the relationship between the demand for money and the interest rate?

Higher interest rates reduce the demand for money because holding money becomes more expensive compared to earning interest. Signup and view all the answers

Study Notes

GDP

GDP measures the total value of all final goods and services produced within a country in a specific time period.
Major components of GDP include:
- Consumption (C): Personal spending on durable goods, nondurable goods, and services.
- Gross Private Investment (I): Spending on capital goods, including non-residential investments, residential investments, and inventory changes.
- Government Purchases (G): Government spending on goods and services; does not include transfer payments.
- Net Exports (NX): Exports minus imports; indicates a country's trade position.
GDP Calculation Formula: ( \text{GDP} = C + I + G + NX )
Value-added: Difference between the value of a finished good and the cost of intermediate goods used in its production.
Nominal GDP fluctuates with prices, while Real GDP accounts for inflation.

Unemployment

Unemployed: Individuals without a job who actively seek work.
Employed: Individuals who have a job or are temporarily away from work.
Labor Force: Total of employed and unemployed individuals; excludes those not seeking work.
Exclusions from the labor force: retirees, full-time students, institutionalized persons, homemakers, discouraged workers.
Key Unemployment Calculations:
- Unemployment Rate (UR): ( \text{UR} = \frac{\text{number of unemployed}}{\text{Labor Force}} \times 100 )
- Labor Force Participation Rate (LFPR): ( \text{LFPR} = \frac{\text{Labor Force}}{\text{working-age population}} \times 100 )
- Employment to Population Ratio (EPR): ( \text{EPR} = \frac{\text{number of employed}}{\text{working-age population}} \times 100 )
Types of unemployment:
- Frictional: Temporary job loss during transitions.
- Structural: Job loss due to economic changes or technological advancements.
- Cyclical: Job loss during economic downturns.
Natural Rate of Unemployment: Level of frictional and structural unemployment in a healthy economy, excluding cyclical unemployment.

Inflation

Inflation: General increase in price levels over time.
Effects of inflation:
- Anticipated Inflation allows individuals to adjust and prepare, causing less disruption.
- Unanticipated Inflation can harm those on fixed incomes and may benefit debtors who can repay with cheaper dollars.

Aggregate Expenditure (AE) and Equilibrium Output (Y)

Main components of AE:
- Consumption (C): Households’ spending on goods and services.
- Investment (I): Business capital spending and inventory changes.
Planned investment vs. Actual investment: Planned is what firms intend to spend; actual is what they successfully spend.
Macroeconomic equilibrium: Occurs when AE equals Real GDP.
The economy adjusts toward equilibrium based on the relationship between AE and GDP.

Fiscal Policy

Fiscal Policy: Government use of spending and taxation to influence the economy.
Differences in types of fiscal policy:
- Automatic Stabilizers: Programs that automatically adjust, such as unemployment benefits and progressive taxes.
- Discretionary Fiscal Policy: Deliberate changes to spending and taxes requiring new legislation.
Effects of fiscal policy:
- Expansionary Policy: Increases in spending or tax cuts to stimulate GDP and potentially raise inflation.
- Contractionary Policy: Decreases in spending or tax increases to reduce GDP and combat inflation.
Key fiscal multipliers:
- Government Spending Multiplier: ( \text{Multiplier} = \frac{1}{1 - MPC} )
- Tax Multiplier: ( \text{Multiplier} = -\frac{MPC}{1 - MPC} )
- Balanced Budget Multiplier: Effect on GDP when both spending and taxes change equally remains at 1.

Money

Money: Asset widely accepted for purchasing goods and services.
Barter System Limitations: Requires double coincidence of wants, lacks a common value measure, and faces indivisibility issues.
Functions of Money:
- Medium of Exchange: Facilitates buying and selling.
- Unit of Account: Provides a standard value measure for pricing.
- Store of Value: Maintains value over time.
Qualities of Money: Must be widely accepted, standardized, durable, portable, and divisible.
Types of money:
- Fiat Money: Value due to government declaration (e.g., U.S. dollars).
- Commodity Money: Intrinsically valuable (e.g., gold).
Broad Measures of Money:
- M1: Includes currency, checkable deposits.
- M2: Includes M1 plus small-time deposits and money market funds.
Money Creation Process: Banks lend a portion of deposits, increasing the money supply.

Aggregate Supply (AS)

Aggregate Supply (AS): Total quantity of goods and services firms are willing to supply at various price levels.
Short-Run Aggregate Supply (SRAS) Curve: Upward sloping; steeper at high output levels due to resource scarcity.
Shifts in the AS curve can occur from changes in labor quantity, quality improvements, and costs of production inputs.### Changes in Capital Stock and Technology
Increase in machinery, tools, and buildings enhances production capacity.
Technological advancements lead to more efficient production processes, boosting overall output.

Aggregate Demand (AD)

Represents the total quantity of goods and services demanded in the economy across various price levels.
Derived by combining the IS curve (interest rate vs. aggregate output) and the Fed Rule (interest rate vs. price level).

Interest Rates and Aggregate Output (IS Curve)

Higher interest rates decrease investment and consumption, resulting in lower aggregate output.
Lower interest rates promote investment and consumption, increasing aggregate output.

Interest Rates and Price Level (Fed Rule)

The central bank adjusts interest rates based on price level changes to stabilize the economy.
Rising prices may lead to higher interest rates to control inflation; falling prices may prompt lower rates to encourage spending.

Shifts in the AD Curve

Monetary Policy: Adjustments in interest rates or money supply by the central bank can shift AD.
Fiscal Policy: Variations in government spending or taxation impact aggregate demand.
Expectations: Household optimism about future income and firm expectations about future profitability can influence investment and consumption.

Long-Run Aggregate Supply

Potential GDP indicates the economy's maximum output when fully utilizing resources.
In the long run, output is unaffected by price level changes as input and output prices adjust.

Macroeconomic Equilibrium (AD/AS Model)

Short-run equilibrium occurs where the AD curve intersects the short-run aggregate supply (SRAS) curve, potentially below potential GDP.
Long-run equilibrium occurs when AD intersects the long-run aggregate supply (LRAS) curve, indicating full employment at potential GDP.

Economic Gaps

A short-run equilibrium below potential GDP indicates a recessionary gap with higher unemployment.
As wages and input prices decrease, the SRAS shifts to the right, restoring potential GDP.

Fiscal Policy Effects

Expansionary fiscal policy seeks to stimulate economic growth by increasing government spending and reducing taxes.
Contractionary fiscal policy aims to slow economic growth, primarily by decreasing government spending and raising taxes.

Monetary Policy Effects

Central bank actions control the money supply and interest rates to achieve economic goals.
Expansionary policy involves lowering interest rates and increasing the money supply; contractionary policy entails raising interest rates and reducing the money supply.

Fed's Response to Z Factors

The Federal Reserve adjusts interest rates and employs various measures to maintain economic stability during underlying issues.

AD Curve Shape based on Fed Focus

If the Fed prioritizes price stability over output, the AD curve may become steeper, resulting in higher unemployment during inflation control efforts.

Zero-Interest Rate Bound

Occurs when interest rates are near zero, limiting the central bank's ability to stimulate the economy through rate cuts.
This condition reduces the effectiveness of monetary policy in promoting spending and investment.

Cost or Supply Shocks

Unexpected production cost increases can lead to lower aggregate supply, raising prices and lowering output.
In zero interest rate scenarios, the Fed employs alternative methods, such as asset purchases, to balance inflation and growth.

Demand Shocks

Sudden shifts in aggregate demand can disrupt output and pricing.
The Fed may adjust interest rates to stabilize the economy by lowering rates during demand declines and raising them during surges.

Balance of Payment Systems

Current Account: Monitors trade in goods and services, income transfers, and remittances, encompassing exports, imports, and income payments.
Financial Account: Tracks investments and financial transactions, including foreign investments and asset exchanges.
Capital Account: Records capital transfers and ownership changes of non-financial assets, encompassing debt forgiveness and migration transfers.

Foreign Exchange Market and Exchange Rates

Demand arises from the need for foreign currency for purchasing foreign goods and services.
Supply reflects the willingness of individuals or businesses to exchange their currency for foreign currencies, determining equilibrium exchange rates.

Currency Appreciation and Depreciation

Currency Appreciation: Occurs when a currency strengthens, allowing it to purchase more foreign currency, often due to increased export demand or high interest rates.
Currency Depreciation: Happens when a currency weakens, reducing its purchasing power for foreign currency, usually resulting from decreased export demand or low interest rates.

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Description

Prepare for the ECON 104 Final with this comprehensive study guide focusing on GDP and its expenditure components. Understand the definitions, implications, and calculations necessary for economic evaluation. This guide will help you grasp the essentials needed for your final examination.