What are some characteristics of a Flexible model compared to the sticky-price model in terms of money? (2)

What are the differences that arise in an decrease in C₀ between the flexible and sticky-price models? (2)

What are some of the flaws of the flexible price model? (3)

Flexible

1) Money is neutral

2) Change in money supply doesn't affect real economy

1) In the flexible, savings increase, real interest rate and prices fall

2) In the sticky-price, aggregate demand falls, employment lowers as well.

1) Real GDP does not always grow by the same rate as potential GDP

2) Unemployment is not always at the natural rate

3) Inflation is not always steady

What are some forms of money? (3)

What are some functions of money? (4)

1) Currency & coins

2) Chequing account

3) Other assets that can turn into cash

1) Medium of exchange

2) Unit of account

3) Store of value

4) Means of deferred payments to settle debts

What is the opportunity cost of money, and what is it equal to?

What does M2 and M2+, M2++ add which makes it different from M1?

It is nominal interest rate, i = r + pi^e     (pi = inflation)

They all add types of deposits, for example M2 adds savings deposits, M2+ adds deposits at other institutions

What is V^L?

What are some financial innovations that affect the money market, and how? (4)

 V_L = trend velocity affected by tech. changes

1) Credit cards - (M^d/P or L decreases) curve shifts down and P increases, velocity is increased

2) ATMs - reduces M^d/P, V increased

3) Internet banking - reduces M^d/P, V increased

4) Interac PMT - reduces M^d/P, V and S increased

When are prices sticky?

What does the stickiness affect? (2)

What are some reasons for prices being sticky? (4)

During the short run.

1) AD

2) Real GDP

1) Menu costs - cost of updating prices

2) Lack of info on economy

3) Prices/wages determined by fairness

4) Money illusion - confused nominal with real prices

What is a Risk Premium?

What is the equation for it? 

What is the relationship between r_L and r_s?

It is a premium that lenders charge for loans to firms rather then to safe government borrowers.

i _risky - i _safe = risk premium

(risky nom. int. - safe nom. int.)

 r_s is the short term real risk rate, r_L is the long term real risk rate

Usually the LR rate > SR rate, both affect investment

What happens to the expenditure multiplier when there are flexible prices?

How about in fixed prices?

If flexible prices, m' = 0

In fixed prices Δy/ΔA > 0

What do Fiscal Automatic Stabilizers do?

What are some characteristics that Fiscal Automatic Stabilizers bring? (3)

They tend to reduce the size of the multiplier

1) Proportional taxes

2) Social welfare programs

3) Open economy has smaller multiplier

What is an important assumption to make in the IS-LM model?

What happens to the multiplier when r is not fixed?

Assume that inflation (pi^e) is given or exogeneous to the model, meaning it is constant. That way we can allow r to be on the y axis.

If r becomes fixed then the multiplier grows smaller.

What is interest rate targeting and how is it shown?

What are some changes that affect the LM curve? (5)

It is when you try to keep interest rates fixed, it is shown when the LM curve is horizontal

1) Money supply (M^s)

2) Price (P)

3) Trend velocity (V^L)

4) Inflation or risk/term premiums

5) Interest sensitivity of money demand (M_i)

What are some changes that can affect the IS curve? (1)

What are some international shocks in the domestic economy with regards to the exchange rate? (3)

1) Any change in MPE (ΔG, Δt, Δε etc.)

1) Increase in foreign demand for domestic exports

(A₀ goes up, IS shifts rightward)

2) Increase in the foreign interest rate (r^f goes up)

(Exchange rate then increases, exports goes up and IS curve shifts rightwards)

3) Increase in ∈₀ means speculators lose confidence in currency (∈₀ increases, r, ∈, Y and IS curve increase)

The AD curve is a relationship between what variables? (2)

What is the AS theory? (2)

What does P^e represent in the AD-AS model?

 What are some other variables that represent the same thing?

1) Price

2) Money stock

1) Misperceptions model (by Lucas) - all goods have imperfect substitutes, don't know the prices of other goods but know the price of your own good

2) Labor contracts - overlapping and non-overlapping

It represents an endogenous variable that derives the AD curve. It is a value that changes based off of info.

The other endogenous variables are P and Y.

1) More is preferred to less (downward sloping curve)

2) Consumer wants diversity in goods (convex curve)

3) All goods are normal goods

What is on the x and y axis of the budget constraint curve?

How does the curve look like, what is the x-intercept?

What happens when T > π, on the budget constraint curve graphically

What is the optimal point between indifference curves and the budget constraint curve?

Leisure vs. consumption.

The curve looks like a straight downward sloping line.

It hits the x-intercept (h) and doesn't go past, becomes a vertical line.

The curve hits that point, after it reaches that point the line becomes vertical at the point (h), the x-intercept.

It is optimal when MRS_{C, L} = w

If C > L then MRS > w (vice versa)

(wages determines slope)

 How does an increase in wage look like on a graph?

Describe the pure income and pure substitution effects.

What is the result on consumption and leisure?

You start at an initial budget constraint with point (A).

Wages increase, the curve shifts outward and is not parallel, the curve now is on point (B).

We draw a parallel line to point (B) and make point (C).

IE: A to C

SE: C to B

Consumption increases, leisure may increase or decrease.

What is the production function?

What does it look like on a graph?

What are the key properties of this function? (5)

Y = zF(K, N^d)

Looks like an exponentially increasing, upward sloping line.

1) Constant returns to scale

2) Output increases when capital or labor input increase

3) MP_L decreases as quantity of labor decreases

4) MP_K decreases as quantity of capital increases

5) MP_L increases as quantity of capital input increases

What are the effects of an increase in z, in the production function? (2)

What is the profit maximizing function?

How does the firm maximize profits?

What does the cost function look like on a graph?

1) Since more output can be produced, production function will shift upwards

2) MP_L increases when z increases

π = zF(K, N^d) - wN^d

It maximizes profits by setting MP_N = w

It is an upward sloping, straight line and

it is shown on a graph with the production function.

What does the slope of the Philips curve depend on?

What causes the MPRF to shift?

In the AD/MPRF Phillips curve, what does the slope depend on? 

What is on the x and y axis of this model?

What is φ made up of? (3)

How sticky prices and wages are, it affects β.

(β = 1.7/θ)

Changes in the TR and IS curves, most shocks increase the MPRF.

Slope depends on φ

On the x axis is real GDP (Y), on the y axis is inflation (π)

It is a product of...

1) real interest rate changes due to inflation rate changes

2) slope of IS curve

3) Okun law's co-efficient

What does the position of the Philips curve depend on? (3)

What does the position of the aggregate demand curve (MPRF) depend on? (2)

What are some factors that affect unemployment? (4)

1) natural rate of unemployment (u^*)

2) expected rate of inflation (π^e)

3) any current supply shocks (ε^s)

1) level of unemployment where real interest rates are at what central banks thinks is long-run avg. rate (u₀)

2) the central bank's target level of inflation (π') 

1) Demographics - more teens, higher unemployment

2) Institutions - strong unions, higher unemployment

3) Productivity growth - less growth, high unemployment

4) Past level of unemployment - both have similar results

What are the ways of forming expectations? (3)

Suppose the gov. stimulates the economy. (fiscal policies)

What happens if it is a surprise?

What happens if it is anticipated?

Explain graphically on the MPRF-Philips curve diagram.

1) Static expectations - ppl ignore that inflation can change (expected inflation doesn't change)

2) Adaptive expectations - assume the future will be similar to the recent past

(good if inflation is moving slowly)

3) Rational expectations - use all the information they have as best they can

-If it is a surprise, MPRF will shift left.

-If it is anticipated, MPRF will shift left but the Philips curve will also shift upwards to make equilibrium.

In both cases, inflation rises and unemployment falls.

What happens in the long run to our expectations graphically? (3)

What does the Beveridge curve represent?

1) Rational expectations - π^e is equal to π

2) Adaptive expectations - people realize that π^e was off, they adjust accordingly and the Philips curve shifts upwards

3) Static expectations - the long run never arrives

A downward sloping curve that shows the relationship of the vacancy rate and unemployment.

In a one-sided search model, describe graphically the ideas presented, identify the curves (2).

What makes the curves shift?

What is the reservation wage rate?

1) The curve is V_e(w) which is the welfare of a worker earning a wage. This curve is upward sloping and the slope of the curve is the separation rate (s)

Decreases with the separation rate (s).

2) The curve V_u is the welfare of the unemployed worker. This curve increases when the unemployment benefit (b) or the frequency at which they receive offers (p) increases. This curve is a vertical line.

These two curves intersect at the reservation wage rate.

The wage where an unemployed worker will start accepting jobs for the given wage or anything above.

(chosen by the unemployed worker)

 What do the two flow functions give us?

What happens to the flow diagram and the welfare of workers diagram when b increases?

What about when p increases?

 In the long run they are equal to one another and when they are equal we can determine the unemployment rate.

The V_u curve shifts up, the UpH(w^*) curve shifts downwards

The V_u curve shifts up, the UpH(w^*) curve shifts upwards

In the two-sided search model, how do we define consumers?

What are some properties of the matching function? (4)

(N = labour force, Q = # of consumers looking for work,

N - Q = # of consumers doing home production,

A = # of firms that post vacancy offers)

1) Constant returns to scale

2) No active consumers or firms = no matches (equals 0)

3) Number of matches (M) increase when Q or A increase

4) Marginal products diminish, less matches per one unit increase in Q or A

(similar to production function)

What does the Nash Bargaining Theory present to the worker and firm?

What are the equilibrium equations in two-sided model? (2)

How do these two curves look graphically?

What effects matching efficiency? (2)

It presents them the total surplus, which is a combination of firm and worker surplus

1) P(Q) = b + em(1, j) * a(z - b)

2) em(1/j, 1) = k/(1 - a) * (z - b)

 The first is upward sloping, the second is downward sloping. They both revolve around labor market tightness.

1) Better technology

2) Government aid

In the two-sided model, what happens when b increases?

What happens when z increases?

What happens when e decreases?

Our P(Q) curve shift upwards and left to a lower j point, it also causes a leftwards movement in the em(1/j, 1) curve.

Our P(Q) curve shifts upwards and left to a higher j point, it causes a rightwards movement in the em(1/j, 1) curve.

Our P(Q) curve shifts downwards and right to a lower j point, it also shifts the em(1/j, 1) curve downwards.

What is a non-overlapping contracts in terms of aggregate demand and supply?

What is the difference between an anticipated and unanticipated change in Aggregate Demand in terms of non-overlapping contracts?

It is a type of model that focuses on one term with a simple contract that has fixed wages.

In an unanticipated change of AD, AD shifts right and prices increase. In the long run, after the contracts are over the AS curve will shift to make new equilibrium.

In anticipated, AS curve shifts along with AD to make the equilibrium instantly.

(similar outcome as misperceptions model)

What is an overlapping contract in terms of aggregate demand and supply?

How do firms and workers behave in regards to wages?

What happens to the model when there is an unanticipated change in aggregate demand?

It focuses on one period where half the workers are hired in the beginning and the other half in the middle. In the middle, the workers also negotiate contracts.

Both parties do not like to change wages, firms do not want to increase wages and workers do not want their wages decreased.

The AD curve shifts rightward, the AS curve then has to shift multiple times leftwards because wages adjust gradually. Eventually it'll reach an equilibrium in long term.

What is the Classical Dichotomy, what does it mean?

What is the difference between expected and unexpected inflation costs?

What is Seigniorage?

At what percent is it considered hyperinflation?

It represent the flexible-price model.

It means that real variables (real GDP, etc.) can be analyzed without considering nominal variables (price, etc.)

 Expected inflation costs are minimal, unexpected inflation costs are significant and can re-distribute wealth between creditors and debtors

It is the revenue made by the gov. by printing money.

20%

In the MPRF - PC graph, what is the main difference in the two equations?

What does a decrease in exports do to the graph?

If the IS curve increases and shifts rightward or the LM curve shifts leftward randomly, what happens to the exchange rate?

the PC curve uses π^e while the MPRF uses π'

It shifts MPRF to the right.

Exchange rate will decrease.