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Final Review – Chapters 5-15 (MACRO) Ch. 5 Price Floor in (unskilled/ entry-level) labor market: Minimum Wage. See Minimum Wage and section and Immigrant Labor Market Project in Chapter 5 of the book. Protectionism through quotas or tariffs/ which price control is not protectionism? Alternative allocative mechanisms Ch. 6 Four stages of a business cycle Durables vs. non-durables in a recession How NBER declares the start/end dates of a recession Several questions on Calculating and Modifying U-Rate (e.g. like Question 1 in Report 1) AD/AS graph, including cost-push vs. demand-pull inflation AD=C+I+G+Xn Winners and losers from (especially unexpected) inflation Ch 7 Output excluded from GDP: Illegal Volunteer Household (chores, construction, cooking/cleaning/driving) DI=PI-PT Ch 8 Malthusian Prophecy, Classical theory and equilibrium at the stationary state are all implied diminishing marginal returns Intensive vs. Extensive sources of economic growth Per-capita output growth rate = GDP growth rate-pop.growth rate New Growth Theory relies on Learning by Doing, Positive Externalities, network externalities and increasing returns to scale. Ch. 9 Until the Depression, the dominant economic theory in developed nations was Classical This theory held that an economy would naturally tend toward FE GDP. This is also based on a very competitive economy. Classical economists prescribe that G=T, both are small relative to GDP, and Laissez-Faire (non-interventionist) policy. They held that: Demand will bounce back from external shocks (wage price flexibility keeps RW constant) 1 Shocks to spending are neutralized by the interest rate (abstinence theory of interest) Supply and demand will be balanced because S creates D (Say’s Law) Thus, a shock may cause an economy to be inflationary or recessionary temporarily, but the economy will naturally return to FE. This implies a vertical LR AS curve. Keynesians challenge all the Classical arguments: Say’s Law applied to 19th Century France, not modern developed economies. Wages and revenue are delinked in modern economies There are more direct ways to influence D than through S Abstinence theory of interest is not correct since savers and investors have different motivations from each other, and from the interest rate. W/P flexibility was restricted on P side by monopoly power and on W side by Unions While real assets may be increasing in a (deflationary) downturn, so is real debt Keynesian conclusion: Monetary and Fiscal Policies should be built in or otherwise triggered to stabile the economy at full-employment and with moderate inflation. Ch 10 Know how to use the expenditure multiplier equation, backwards and forwards. Initial change in AE * M = Change in GDP Expenditure multiplier = 1/ 1-MPC MPS + MPC = 1 Impact of just a change in taxes: inverse to C and I - for example: change in C= -(increase in $’s paid to a tax)*MPC So if you have 200B more in taxes, and MPC = .8 Change in C= -(200B*.8) = -160B That would be the initial expenditure change. Just as if G, I or NX declined by 160 Billion, in this case C declined 160 B. The multiplier equation in this case would be: -160 * (1/(1-MPC)) = -800 As always, initial impact to AE (in this case, Change in C)*M= Change in Y 2 So the total impact on GDP is expected to be – 800B, a contraction in annual output of $.800B ….This is contractionary fiscal policy – economic contraction induced by the Gov’t decreasing G or increasing T…..When would they want to carry out contractionary fiscal policy? When GDP exceeds GDP*, an inflationary gap exists. So if current GDP was 7.8 Trillion Dollars (T) and GDP* is 7T, then the 200 Billion dollar tax increase that began this process is a means of cooling the economy down (preventing inflation). Bal. Budget multiplier = 1 Chapter 11 Four Functions of Money. M1 is currency coins and checking accounts M2 is M1+ savings and small value time deposits Money Creation Eqn: Initial injection*(DM) = new money created Reserves must be kept in vault cash or accounts with the Fed TR=RR+ER DM = 1/r and r= RRR Understand what is r (RRR) itself as opposed to DM which is 1/r Leakages E and C Leakage-Adjusted DM - 1/(r+e+c) Ch. 12 Specific Fed Powers as opposed to… General Fed Powers: (Control of the flow of credit aka the ir) Open Mkt Ops – alters FFR rate banks loan excess reserves to each other DR for a direct Fed-to-bank loan RRR What can vary on a bond, and what is fixed? Understand the impact (and causes) of D or S shifting in the T-Bill market (see MS-MD worksheet. Chapter 13 Eqn of exchange: MV=PQ V= 5 to 6 in recent years For Quantity Theorists of Money (aka Monetarists), the Eqn of Exchange MV=PQ is viewed as left to right, increases in M causes inflation (an increase in P) 3 V and Q are fixed ( in the case of Q, viewed as exogenous) This implies a rule based non-discretionary (or highly infrequently discretionary) Fed actions. Monetarists are Inflation hawks and hold that the economy is very competitive. Institutional Theorists favor and incomes policy that uses the leverage of the government to pressure low increases in P and W, largely based on an insider-outsider model that says factor markets in particular are not as competitive as they could be due to social, legal, organizational, and indirect exclusion that occurs. They view increases in P causing increases in M, or a right-to left reading of MV=PQ. They argue that if the lack of perfect competition could be reduced, so would inflation. Managed inflation Employment is #1 priority -Obstacles to the Fed actions. -Phillips Curve is confirmed with AD shifts, not with SAS shifts. -Central Bank Independence/ closely overlaps with Central Bank Credibility Chapter 15 Most important, be able to use Ch. 15 equations: Find passive deficit using a tax rate t: Passive deficit=t*(Y*-Current Y) Passive deficit + Structural deficit= Actual deficit Real def = Nominal def – Inflation*Debt Note, if any of these deficits, passive, structural, or actual is negative, remove (–) sign and call it a (passive, structural, or actual) surplus SS (currently and in recent decades) overstates surpluses and reduces the reported deficit The Nat’l debt (total of each year’s deficit minus any surpluses) is very large, interest rates are high and rising, and deficit timing is often questionable when the economy is close to Y* (potential output) on its own. Public Spending crowding out private spending is also a concern Understand the basics of all these Proposals for reducing debt: 1. Line-Item Veto 2. Privatization Asset selling Contracting Out Gov’t services 3. Capital Acct- Current Acct Budgeting: changes in budgetary procedures so only Capital Investment (Infrastructure, roads, dams) will have debt as a financing option 4. BB Amendment (Straightjackets Congress/ arguably dooms economy) 5. Two-Wage Economy (part of wage tied to profits of each firm – can cause fellowworker problem) Also understand proposals to address the deficit in the article called “The Vigilante” on the Macro site. Note – not all of these strategies actually reduce the deficit. Some just delay or help relieve the problem. 4