Download Final Exam Study Guide Econ 301 Intermediate Macroeconomics

Final Exam Study Guide
Econ 301
Intermediate Macroeconomics
Generally you can expect the same combination of conceptual knowledge, graphs,
algebra, and calculations that you’ve seen all semester. I hope all this helps!
The idea of an Automatic Stabilizer connects you to knowledge of
1. national income accounting identities (Z=C+I+G+NX)
2. equilibrium conditions (Y=Z)
a. The graphical analysis of this model
3. marginal propensity to consume
4. differential multiplied effect of government spending and taxes on total
spending
5. the effect of changes of income on G and/or T and then back to income (which is
the concept of an automatic stabilizer)
To actually derive the workings of an automatic stabilizer, you need to be able to do
the algebra. Hence problem 5 in chapter 3 is essential.
The effect of a change in government spending on investment requires
1. Knowledge of goods market equilibrium
a. How do changes in spending affect output?
b. How do changes in interest rates affect spending?
c. What happens in the goods market if autonomous C, I, G, or T change?
d. What exactly determines the shape, the slope, and the position of the IS
curve?
i. What if income didn’t affect spending?
ii. What if interest rates didn’t affect spending?
iii. What if expectations of future shocks (created, perhaps, by
current shocks) affect spending on goods?
For example, if the government raises taxes today, this reduces disposable
income and puts downward pressure on spending. But if the tax hike is part of
a program to restore fiscal sustainability and solvency to the country, it might
actually lead to more spending.
2. Knowledge of money market equilibrium
a. What determines money supply? Money demand?
b. What do changes to income to do money demand?
c. What do changes in money demand/supply do to interest rates?
d. What happens in the money market if MS or autonomous money demand
change?
e. What exactly determines the shape, the slope, and the position of the LM
curve?
i. What if income didn’t affect money demand?
ii. What if interest rates didn’t affect money demand?
iii. What if the money supply curve were upward sloping ?
For example, banks might supply more loans and deposits at higher interest
rates.
f. What would happen to the LM curve if money supply were so large that
interest rates went down to zero? (this is called the “liquidity trap”)
3. Working knowledge of the IS and LM curves and simultaneous equilibrium of
output and interest rates.
To actually derive the effect of a change in government spending on investment, you
need to be able to do the algebra. Hence problem 3 in chapter 5 is essential.
Understanding the effects of a fiscal expansion on net exports requires
1. Grasp of the IS-LM model. What happens to interest rates when G-T increases?
What happens to equilibrium output?
2. The Interest Parity Condition. What happens to E if i increases?
3. The relation between net exports, output, and the exchange rate.
a. What happens to NX as domestic equilibrium output increases?
b. What happens to NX as E appreciates?
4. You may want to rely on the discussion in section 20.4.
Understanding the medium-run neutrality of money requires
1. Knowledge of the reasons for the slope of the AD curve and for what causes
shifts to the AD curve.
a. What happens to equilibrium output if autonomous C, I, G, or T change?
If MS or autonomous money demand change?
i. How do each of these shocks work their way through moneymarket equilibrium,
ii. goods market equilibrium,
iii. and IS-LM?
b. At a given rate of growth of money supply, higher inflation reduces real
money balances. As the purchasing power of money falls, the interest
rate rises, which makes expenditure fall. This leads to lower equilibrium
output: the economy moves along its AD function.
2. Knowledge of the reasons for the slope of the AS curve and for what causes
shifts to the AS curve.
a. Higher equilibrium output reduces unemployment. This strengthens
workers’ bargaining power and causes them to demand faster wages,
which pushes up inflation. So higher equilibrium output leads to higher
inflation.
b. The position of the AS curve depends on expected inflation: higher
expected inflation raises demands for raises by workers, which pushes up
inflation at any level of output.
c. Expected inflation depends on past levels of inflation. So if inflation has
risen recently, eventually workers update their expectations to a higher
rate.
3. Knowledge of the distinction between
a. The short run (where expectations don’t catch up with actual inflation
and unemployment can be different from the natural rate, leading to
discrepancies between the output growth rate and the normal output
growth rate) and
b. The medium run (where inflation = expected inflation, unemployment =
natural rate of unemployment, and output growth rate = normal output
growth rate)
4. You may want to rely on the discussion in section 7.4 and on my notes.
Understanding changes in stock prices in response to a monetary expansion requires
1. Knowledge of the formula for expected discounted present value.
2. Knowledge of the short-run and medium-run effects of a monetary expansion on
output and the interest rate
3. Exercise 5 in chapter 15 explores this, which explains some of the reaction of the
market to the expansionary policy used to deal with the financial crisis of 2008.
Understanding the effects of saving on long-term economic growth requires
1. Knowledge of the rules of exponents.
2. Knowledge of the basic Solow Growth model: the aggregate production function,
the saving equation, the capital accumulation equation, and the steady-state
definition.
3. Knowledge of basic algebra to combine and rearrange those four equations, and
to solve for
a. steady-state capital-per-worker,
b. output-per-worker, and
c. the capital-output ratio.
4. Look at the Appendix to Chapter 11, at my notes for chapters 10-11, at exercises
6 and 8 in chapter 11, and at pages 229-232.
Understanding the concept of convergence requires
1. Understanding the concept of diminishing returns to capital, and how it acts on a
set of countries that have a similar level of technology and institutions.
Understanding the calculation of the optimal (golden-rule) saving rate requires
1. Knowledge of how to set up an equation (the steady-state consumption
equation) so that it will yield the answer one needs.
2. Knowledge of basic calculus.
3. Understanding the application of marginal cost and marginal benefit to this
situation.
4. Exercise 5 in chapter 11 explores this. See my notes.
Understanding the effects of technological progress and population growth on long-run
growth requires
1. Knowledge of rules of growth rates.
2. Knowledge of how to change a basic model to make it more realistic: turning the
Solow growth model from levels (of output or capital) to growth rates.
3. Ability to use the concepts together with algebra to find an algebraic expression
for the growth rates of output-per-worker and capital-per-worker in the steadystate.
4. Understanding why monetary issues are irrelevant in the long run (if they don’t
affect real variables, they don’t affect A, K, or L), so that the Keynesian model is
not helpful for growth economics.
a. Probably saying that “monetary issues don’t affect A, K, or L is too strong.
What if monetary policy doesn’t fight recessions so that the economy is
very volatile; or if it fails to keep inflation low and stable – wouldn’t this
affect technological progress or capital accumulation?
b. What is the role of technological shocks in generating volatility? Could
we generate a model of short-run fluctuations based on positive or
negative shocks to A?
c. What is the role of fiscal policy in encouraging A, K, or L? On the one
hand, there’s the (potentially positive) effect of government spending on
infrastructure, education, research and development, etc. On the other,
there’s the (potentially negative) effect of deficits and high debt-to-GDP
ratios on real interest rates and investment (crowding out) and therefore
on economic growth?
5. Look at table 12-1 and my notes for Chapter 12.
Understanding issues of fiscal sustainability requires
1. Knowing the basic differences between debt and deficit; between primary deficit
and overall deficit; and between overall debt and debt held by the public.
2. Understanding the basic formula for the debt-to-GDP ratio. Explain its
components and how it is related to the government budget constraint.
3. Understanding how we calculate the primary fiscal deficit that is consistent with
debt sustainability, given interest rates, inflation, debt levels, and growth.