# Macro Economics Test Questions Essay

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Until what point do firms hire new workers?

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?

because of the diminishing returns
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why does labor supply slope upward

because at higher wages workers are willing to work more
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what determines the level of employment and the wage

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….

Income Tax on workers
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Changes in Labor Demand

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

unemployment is on the x axis wages are on the y axis
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What are the two kinds of unemployment

natural rate of employment frictional unemployment structural unemployment Cyclical unemployment
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Actual Employment=

Natural+Cyclical =Frictional+Structural+Cyclical
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What is the natural rate of employment

rate that would prevail if the economy was in neither a boom nor a recession
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Cyclical unemployment

difference between the actual rate and the natural rate and is associated with short run fluctuations
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frictional unemployment

when workers are changing jobs in a dynamic economy. Likely to occur
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structural unemployment

labor market institutions that match up workers ad firms in the labor market.
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Bathtub Model of Unemployment

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

employed people who lost their jobs
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ƒUt what does this mean in terms of: ∆ Ut+1 = sEt -ƒUt

unemployed people who find new jobs
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what does s(bar) mean in terms of ∆ Ut+1 = sEt -ƒUt

s (bar)= job separation rate
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what does Et=?

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

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

when 0= sEt -ƒUt therefore, U*=s(bar)L(bar)/ ƒ (bar) + s(bar)
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Present Discounted Value definition

value of a financial amount that is paid in the future
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Present Discounted Value equation

FV/ (1+R)^t R= constant interest rate
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Present Discounted Value in a geometric series equation

1-a^(n+1)//1-a a= 1/1+R
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what is a monetary base

broader measure of currency in circulation
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Quality Theory of Money equation

MtVt=PtYt
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What is Vt in terms of MtVt=PtYt

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

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

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?

Yt= Y(bar)t real GDP= exogenous variable)
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In the classical dichotomy the velocity of money is changed how?

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?

Mt=M (bar)t exogenous variable
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quantity theory for the price level equation

Pt*=M(bar)tV(bar)//Y(bar)t
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what does the quantity theory for the price level equation say…

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

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……

the money supply.
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Quantity theory for inflation inflation rate=

inflation rate= % ∆ in aggregate price
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growth equation for the theory of money

g(bar)m +g(bar)v = g(bar)p +g(bar)y
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rate of inflation π* what does it imply

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….

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

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=

MPK
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what helps us convert between real and nominal GDP?

price level
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fischer equation

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

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

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?

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?

decrease in investment decrease in output downward sloping curve
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Yt= what do these variables stand for?

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=

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

because it has already been determined by the long run model
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a(bar)c≈??

2/3 think of the production function
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Investment equation variables

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?

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…….

saving their retained earnings
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If r (bar) ↑ compared to Rt then firms are better off

borrowing at real interest rate and investing the proceeds in capital
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A high value of b (bar) indicates

sensitivity to a ∆ in Rt and r (bar)
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In the long run Rt= ??

r (bar) real interest rate must be equal to MPK
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when ∆ in interest rates happen when is r (bar) affected?

r (bar) does not change immediately. Only until capital is installed and put to use.
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Deriving the IS Curve equation

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

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??

movement along the curve
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if a (bar) ↑↓ then the curve….

shifts
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∆ in Y(bar)t affect the IS curve…..

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

people will base their consumption on an average of their income rather than their current income
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life cycle model

consumption is based on average lifetime income
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Multiplier Effects for consumption, Ct

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

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

1. gap between Rt and r(bar) 2. cash flow
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high cash flow ….. low cash flow….

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

a(bar)iY(bar)t – b(bar)(Rt-r(bar))Y(bar)t
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what is the federal fund rate

interest rate paid from one bank to another for overnight loans.
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MP Curve is used for what

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

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

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

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?

YUP BITCH
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IS/MP Diagram what does it plot Rt=?? a(bar)=??

plots real interest rates that the central bank chooses Rt=MPK r(bar) a(bar)= 0
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Inflation rate πt=

Pt+1-Pt// Pt πt= πte + v(bar)Ÿt ^expected inflation ^^demand conditions
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πte=

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

πt=πt-1 + v(bar)Ÿ describes how inflation evolves over time as a function of short run output
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∆πt= ?

=v(bar)Ÿt
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what does v(bar) measure a high v(bar) means…… a low v(bar) means……

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

πt= πt-1 + v(bar)Ÿ
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∆πt=

=v(bar)Ÿ +δ
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what is cost push inflation

cost increases tend to push ↑πt
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demand pull inflation

↑ aggregate demand ↑πt
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what is the rate of inflation based off of

the πt that firms expect is equal to last years inflation rate state of the economy, v(bars)Ÿ shock to inflation, δ