Macro Economics Test Questions Essay

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Until what point do firms hire new workers?
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until the additional output produced by the last worker ( MPL) equals the cost of hiring that worker (wage)
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why does labor demand slop downward?
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because of the diminishing returns
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why does labor supply slope upward
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because at higher wages workers are willing to work more
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what determines the level of employment and the wage
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equilibrium
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If labor force is fixed, L(bar), then the intersection of Ld and Ls (equilibrium) also determines the employment-population ratio, L/N,
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Changes in Labor Supply….
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Income Tax on workers
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Changes in Labor Demand
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government regulations reduction in labor demand
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When plotting labor demand and labor supply what is on the X and Y Axis
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unemployment is on the x axis wages are on the y axis
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What are the two kinds of unemployment
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natural rate of employment frictional unemployment structural unemployment Cyclical unemployment
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Actual Employment=
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Natural+Cyclical =Frictional+Structural+Cyclical
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What is the natural rate of employment
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rate that would prevail if the economy was in neither a boom nor a recession
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Cyclical unemployment
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difference between the actual rate and the natural rate and is associated with short run fluctuations
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frictional unemployment
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when workers are changing jobs in a dynamic economy. Likely to occur
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structural unemployment
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labor market institutions that match up workers ad firms in the labor market.
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Bathtub Model of Unemployment
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Et + Ut = L (bar) THe number of people in the labor force is the sum of employment Et and the number of people who lose their jobs ∆ Ut+1 = sEt -ƒUt
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sEt what does this mean in terms of: ∆ Ut+1 = sEt -ƒUt
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employed people who lost their jobs
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ƒUt what does this mean in terms of: ∆ Ut+1 = sEt -ƒUt
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unemployed people who find new jobs
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what does s(bar) mean in terms of ∆ Ut+1 = sEt -ƒUt
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s (bar)= job separation rate
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what does Et=?
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the number of people who start out with out jobs.
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explain each parameter: ∆ Ut+1 = sEt -ƒUt What are the two endogenous variables
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ƒ(bar) job finding rate Ut= # of unemployed people Et and Ut
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what is the steady state for ∆ Ut+1 = sEt -ƒUt
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when 0= sEt -ƒUt therefore, U*=s(bar)L(bar)/ ƒ (bar) + s(bar)
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Present Discounted Value definition
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value of a financial amount that is paid in the future
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Present Discounted Value equation
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FV/ (1+R)^t R= constant interest rate
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Present Discounted Value in a geometric series equation
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1-a^(n+1)//1-a a= 1/1+R
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what is a monetary base
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broader measure of currency in circulation
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Quality Theory of Money equation
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MtVt=PtYt
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What is Vt in terms of MtVt=PtYt
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the velocity of money// average times per year that each piece of paper currency is used in a transaction
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what does the left side of the equation represent in the equation: MtVt=PtYt
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the left side represents the amount of $$ in circulation, Mt, multiplied by the number of times each piece of paper changes hands, Vt
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What is the classical dichotomy
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in the long run the real and nominal sides of the economy are completely separate Real GDP in the long run is determined by real variables.
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in the classical dichotomy is GDP and exogenous variable or an endogenous variable?
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Yt= Y(bar)t real GDP= exogenous variable)
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In the classical dichotomy the velocity of money is changed how?
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Vt=V (bar) no time subscript because the velocity is constant over time
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In the classical dichotomy the amount of money in circulation, Mt, is changed how?
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Mt=M (bar)t exogenous variable
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quantity theory for the price level equation
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Pt*=M(bar)tV(bar)//Y(bar)t
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what does the quantity theory for the price level equation say…
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says that the price level is determined by the ratio of the effective quantity of money M(bar)tV(bar) by the volume of goods Y(bar)t
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in terms of the quantity theory for the price level, if you increase the money supply what happens to the price and real GDP
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increase in P and decrease in real GDP
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in the long run, a key determinant of the price level is the level of……
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the money supply.
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Quantity theory for inflation inflation rate=
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inflation rate= % ∆ in aggregate price
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growth equation for the theory of money
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g(bar)m +g(bar)v = g(bar)p +g(bar)y
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rate of inflation π* what does it imply
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g(bar)m-g(bar)y quantity theory implies that in the long run, ∆ in the growth rate of money leads one for one to the ∆ in the inflation rate (π)
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increase in the growth of the amount of $$ in circulation, g(bar) m, in the long run….
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leaves the real economy unaffected ( bc of teh classical dichotomy), so the only ∆ will be an ↑ in π
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neutrality of money does it hold in the short run
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the proposition that the ∆ in the money supply have no real effects on teh economy and only affect prices does not hold in the short run
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real interest rate=
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MPK
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what helps us convert between real and nominal GDP?
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price level
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fischer equation
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i= R+π i= nominal interest rate R= real interest rate π= rate of inflation
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Government Budget Constraint Explain the variables
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G=T +∆B +∆M T= tax revenue B= borrowing, ∆B amount of new borrowing M= stock of money ∆M amount of new issued by government
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seignorage/ inflation tax who is the tax paid by
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revenue the govnt obtains by issuing new money, ∆M tax is paid by people holding currency
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What does the IS Curve plot?
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Interest rate ( y axis) short run out put ( x axis)
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in the IS Curve as interest rate increases what happens to investment and output?
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decrease in investment decrease in output downward sloping curve
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Yt= what do these variables stand for?
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Ct + It+ Gt+ EXt- IMt C=consumption I=investment G= government spending EXt-IM= net exports
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Ct= Gt= EXt= IMt= It=
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a(bar)cY(bar)t a(bar)gY(bar)t a(bar)exY(bar)t a(bar)imY(bar)t It/Y(bar)t= a(bar)i-b(bar)(Rt-r(bar))
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Why is GDP an exogenous
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because it has already been determined by the long run model
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a(bar)c≈??
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2/3 think of the production function
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Investment equation variables
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a (bar)t= long run fraction of potentioal output Rt= real interest rate r (bar)= MPK Rt= rate at which firms can save or borrow r (bar)= amount of additional putput the firm can produce by investing in one more unit of capital
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the amount of investment depends on what?
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the gap between real interest rate Rt and MPK r(bar)
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In the classical dichotomy the amount of money in circulation, Mt, is changed how?
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In the classical dichotomy the velocity of money is changed how?
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if r (bar)↓ compared to Rt then firms are better off…….
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saving their retained earnings
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If r (bar) ↑ compared to Rt then firms are better off
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borrowing at real interest rate and investing the proceeds in capital
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A high value of b (bar) indicates
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sensitivity to a ∆ in Rt and r (bar)
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In the long run Rt= ??
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r (bar) real interest rate must be equal to MPK
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when ∆ in interest rates happen when is r (bar) affected?
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r (bar) does not change immediately. Only until capital is installed and put to use.
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Deriving the IS Curve equation
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Ÿ= a(bar)- b(bar) (Rt-r (bar))
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In the long run a (bar)=??
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The Basic IS Curve
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Ÿ is on the x axis and R is on the y axis downward slopping line
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Effect of a ∆ in interest rates….. does it move the curve or is it a movement along the curve??
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movement along the curve
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if a (bar) ↑↓ then the curve….
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shifts
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∆ in Y(bar)t affect the IS curve…..
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does not affect the IS curve since it is not in the equation Short run output Ÿt is unaffected by a ∆ in potential output
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permanent income hypothesis
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people will base their consumption on an average of their income rather than their current income
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life cycle model
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consumption is based on average lifetime income
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Multiplier Effects for consumption, Ct
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Ct/Yt= a(bar)c + X(bar) Ÿc When consumption responds to temporary ∆ in income
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Multiplier Effect for Ÿ what is x (bar) between
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Ÿ= 1/ 1-X(bar) ** a(bar)- b (bar) (Rt-r(bar)) ^^multiplier ^^ IS Curve 0 and 1
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2 determinants of investments
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1. gap between Rt and r(bar) 2. cash flow
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high cash flow ….. low cash flow….
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makes it easy to finance additional investments forces a company to borrow more expensive to borrow than to use its own internal funds
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It with multiplier effects equation
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a(bar)iY(bar)t – b(bar)(Rt-r(bar))Y(bar)t
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what is the federal fund rate
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interest rate paid from one bank to another for overnight loans.
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MP Curve is used for what
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it is how the central bank sets the nominal interst rate and then exploits the trend of real and nominal interest rates moving closer together in the short run
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MP Curve→IS Curve→Phillips Curve Explain
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Nominal interest rate determines real interest rate → real interest rate influences GDP (short run)→ describes how economic fluctuations affect the evolution of inflation
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Fischer Equation how does a ∆ in nominal interest rates affect this
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Lt=Rt+πt Rt- it- πt ∆ in nominal interest rates will lead to a ∆ in real interest rates….. as long as it isn’t offset by inflation
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sticky inflation assumption
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rate of inflation does not respond to a ∆ in MP.
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Can central banks set real interest rates in the short run?
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YUP BITCH
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IS/MP Diagram what does it plot Rt=?? a(bar)=??
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plots real interest rates that the central bank chooses Rt=MPK r(bar) a(bar)= 0
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Inflation rate πt=
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Pt+1-Pt// Pt πt= πte + v(bar)Ÿt ^expected inflation ^^demand conditions
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πte=
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πte=πt-1 expected inflation is equal to the inflation from the past year
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Phillips Curve equation what does it describe
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πt=πt-1 + v(bar)Ÿ describes how inflation evolves over time as a function of short run output
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∆πt= ?
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=v(bar)Ÿt
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what does v(bar) measure a high v(bar) means…… a low v(bar) means……
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measures how sensitive inflation is to demand conditions governs slope high v(bar) means price setting behavior is sensitive to the state of the economy low v(bar) means it takes a large recession to reduce πt
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Price shocks and Phillips Curve equation
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πt= πt-1 + v(bar)Ÿ
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∆πt=
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=v(bar)Ÿ +δ
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what is cost push inflation
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cost increases tend to push ↑πt
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demand pull inflation
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↑ aggregate demand ↑πt
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what is the rate of inflation based off of
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the πt that firms expect is equal to last years inflation rate state of the economy, v(bars)Ÿ shock to inflation, δ

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