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Ante Real Interest Rate
What is expected. R = i - E π
Post Real Interest Rate
Actuals. R= i-π
When borrowers and lenders negotiate loans they do not know what future inflation will be.
Fisher Effect Formula. Explain.
i = R + Eπ. If the real interest rate is constant then the nominal interest rate (i) moves one-for-one with changes in expected inflation (Eπ).
What is the opportunity cost of holding money?
- Difference between the Rate of return (r) and the return of holding money (- Eπ).
- Opportunity cost = R + Eπ
5 Real variables
- Y= income
- C= consumption
- I= investment
- w/p= mpl (marginal productivity of labor)
- r/p = mpk (marginal productivity of capital)
separation between real and nominal variables
3 Nominal Variables
- p= price level
- w= wages
- π = inflation
Under the classical dichotomy changes in money supply (M) are neutral i.e. cannot effect real variables in the long run.
Marginal Productivity of Capital (MPK) formula (real rent of capital) and def.
MPK = R/P (rent / price level) . MPK is the change in output for a unit change in capital input.
Under perfect competition:
Workers earn _____?
Capital earns ________?
- Y= MPL * L + MPK * K + Economic Profit
- (economic profit is zero under perfect competition and constant return to scale)
Keynesian consumption function. Expain.
Marginal Propensity to Consume (MPC) How much consumption changes by for a unit of increase in disposable income (YD ). Y-axis is consumption, x-axis is Yd slope is MPC [C= c(Y-D)] which is positive slope.
Earn more you consume more.
What is the slope of the consumption function?
How do they invest?
- Both firms and households invest.
- Firms invest by changing capital stock and inventories
- Households invest by buying a new house.
Real Interest Rate Formula
R = i - π ( real interest rate = nominal interest rate - inflation)
Affects of low real interest rate?
Low interest rate mean that people are willing to invest. Investments is inversely (negatively) the real interest rate.
How do government spend?
What do government payments?
- Spend by purchasing goods and services.
- Government makes welfare payments, unemployment payments, and other payments.
- Taxes and Government spending is in Balance Budget.
- Taxes in greater than Government spending Government Surplus.
- Taxes in less tan government spending, government deficit.
National Savings (s) formula
S = Y-C-G
National savings formula
- Private savings + Public Savings = National savings
- (y-c-t) + (t-g)
What is M1 and M2?
- M1 (monetary aggregate) = highly liquid= C+DD+ travelers check+ and other deposits
- M2 = less liquid= M1+ savings+ small time deposits + shares in money market funds
What is the Quantity Equation Formula
What is the Real money demand Quantity theory
- (M/P)D =kY
- The demand for real money balances is proportional (k) to income (Y).
- As income increases real money balances increases.
What happens if velocity and price level is kept constant in the Quantity Equation.
If money supply increases, income also increases. Typically in the short run.
What happens when income and velocity is kept constant in the Quantity Equation Formula?
When money supply increase, price level increase. Typically happens in the long run.
Note: increasing the money supply and increasing the price level will result in inflation.
Number of people losing jobs = number of people finding jobs
Halls Model Labor Force formula. Explain. What happens if we decrease unemployment rate?
- U/L= s/(f+s). Unemployment rate depends on the rate of jobs separation and job finding.
- If unemployment rate is decreased the we can see a decrease in job separation and increase in job finding.
- (increasing the number of people findings jobs and decreasing the number of people losing jobs)
What are some reasons for unemployment? (frictional unemployment)
frictional unemployment: time taking to find a new job
- People have different job preferences
- imperfect job information
- geographical preferences
What does public policy do?
- reduce frictional unemployment by employing as many people by:
- posing job information about position available
- unemployment benefits- unemployed are paid a fraction of their wages.
What is an example of structural unemployment?
Wage rigidity= wages are not flexible and do not adjust to market conditions.
Explain how minimum wages comes about. Graphically.
Classical approach minimum wages is flexible while in the kaizen it is slow to adjust.
- y-axis = w/p
- x=axis = L
- slope (negative) = DL
- kept constant= Lbar (x-axis) line SL you get a (w/p)* = wages are in equilibrium.
- Minimum wage (w/p)min is found above the wage equilibrium.
- A binding minimum wage Wmin is imposed so the real wage is above (w/p)*
- Supply of labor (w/p)min is Lbar, and Lmin workers are hired.
Structural unemployment formula. Explain.
- Structural unemployment= Lbar- Lmin
Minimum wages affect low skilled workers such as teenagers.
Long rum unemployment in the US is typically____?
Finding a Job is not _____________.
Job search is an example of _______________.
Wage rigidity is a ____________________.
- structural unemployment
- frictional unemployment
Disadvantages to unemployment?
- unemployment is a waste of resources
- difficult to reduce structure and frictional unemployment
- public policy sometimes increases unemployment rate for example unemployment insurance.