The Herfindahl Index (H) ranges from 1 / N to one, where N is the number of firms in the market. Equivalently, if percents are used as whole numbers, as in 75 instead of 0.75, the index can range up to 100², or 10,000.

A HHI index below 0.01 (or 100) indicates a highly competitive index.
A HHI index below 0.15 (or 1,500) indicates an unconcentrated index.
A HHI index between 0.15 to 0.25 (or 1,500 to 2,500) indicates moderate concentration.
A HHI index above 0.25 (above 2,500) indicates high concentration[1].

Full = no cyclical unemployment

Natural rate UE = frictional + structural UE

Effects on aggregate demand:

Expected Inflation, Expected Income level, Increase in govt spending

Interest rates -- decrease

Consumption, spending, AD -- increase

Main factor leading to business cycles and deviations from full-employment is monetary policy. To keep AD stable and growing -- central bank should follow policy of steady increases in MS. Recessions caused by inappropriate actions to decrease MS.

Also believe downward sticky. 

Keep taxes low.

Create liquidity

Financial intermediaries

Minitor the risk of loans

Pool the default risks of individual loans

Discount rate

Bank reserve requirements

Open market operations

Increase = Increase interest rates

Decrease = decrease

(only works if banks willing to lend/customers willing to borrow)

Buying = decrease interest rates

Selling = increase IR

(1+c) / (r + c)

c = currency drain as percentage of deposits

r = required reserve ratio

Money supply x Velocity = Price x Real Output

(both = GDP)

MV = PY

Average # times/yr each dollar used to buy G/S.

V = GDP / money

An increase in MS will cause proportional increase in prices

P = M (V/Y)

Inverse relationship between inflation rate and unemployment rate.

AS decreases as real wages rise, resulting in SR decreases in GDP/employment. Actual inflation is less than anticipated inflation, and UE increases. 

Eventaully new lower rate of inflation correctly anticipated.

National savings

Borrowing from foreigners

Government savings

Disc: Spending and taxing decisions of natl govt that are intended to stabilize economy. 

Auto: Govt spending changes that occur when economic growth slows or accelerates, but do not require action by policy makers

Instrument rule based on rate of inflation and output gap:

FFR(target) = Rate of Inflation + Real FFR + 0.5(Inflation - Target Inflation) + 0.5[log(real output) - log(potential output)]

FFR(target) = r* + pi + 0.5(pi-pi*) + 0.5(output gap = y - y*)

FFR(target) = nominal FFR

r* = real federal funds rate

pi = rate of inflation

pi* = target rate of inflation

y = log(real output), y* = log (potential output)

(1)Improvements in technology and productivity

(2)Increases in the supply of resources

(3)Institutional changes that increase the efficiency of resource use

Short-run = cyclical

Long-run = frictional, structural

(1) Wages

(2) Size of adult population

(3) Accumulation of capital

(1) Changes in costs of production (inputs) -- Cheaper shifts curve to right, more expensive left

(2) Technological improvements -- Shift to right

(3) Change in size of industry

(1) Issue country's currency

(2) Regulate its banking system

(3) Manage money supply

Both increase.

Multiplier effect stronger for G vs tax increase. All govt spending enters economy as increased expenditure, whereas only a portion of tax increase results in lesended expenditure (dep on marginal propensity to consume). 

All of M1 +

time deposits

savings deposits

money market mutual fund balances

Effect of open market sale of Treasury securities on:

short-term rates, long-term rates, currency, exports

Short and long term interest rates increase.

Rate increase causes dollar to appreciate, reducing foreign demand for domestic goods, causing exports to decline.

The correct answer was C) independent of price and perfectly inelastic.

The supply of renewable resources over a period of time is fixed. The supply of renewable resources is, therefore, independent of price and perfectly inelastic.

The correct answer was C) frictional unemployment.

Frictional unemployment exists because workers and employers do not have perfect information and must expend time and resources on search activities. 

Your answer: A was correct!

An increase in interest rates can be expected to decrease business investment and decrease consumption. The impact on government spending and net exports is not clear-cut. 

B

The short-run supply curve for a firm is its marginal cost curve above the average variable cost curve. The short-run supply curve of the market is the sum of the supply curves for all firms in the industry.

(1) When other factors fixed, labor demand is _____ elastic in the short run

(2) The more labor-intensive a firm's production processes, the _____elastic the firm's demand for labor will be

The fact that other factors of production are fixed makes labor demand less elastic in the short run.

A firm will have more elastic labor demand when labor represents a larger proportion of its input costs.

Your answer: C was correct!

A greater than expected increase in aggregate demand suggests that actual inflation will exceed expected inflation and unemployment will decrease.

Mainstream -- Aggregate Demand

Real -- Productivity

The correct answer was A) budget deficit will increase the real interest rate and thereby retard private investment.

Increased budget deficits will increase the demand for loanable funds and lead to higher interest rates and thus lower private investment. Crowding-out implies that an increase in government spending will choke off private investment and reduce the intended impact of fiscal policy changes on aggregate demand.

Changes in aggregate demand. Changes in aggregate demand are represented by shifts of the aggregate demand curve. An illustration of the two ways in which the aggregate demand curve can shift is provided in Figure 2 . 

A shift to the right of the aggregate demand curve. from AD₁ to AD₂, means that at the same price levels the quantity demanded of real GDP has increased. A shift to the left of the aggregate demand curve, from AD₁ to AD₃, means that at the same price levels the quantity demanded of real GDP has decreased.

Changes in aggregate demand are not caused by changes in the price level. Instead, they are caused by changes in the demand for any of the components of real GDP, changes in the demand for consumption goods and services, changes in investment spending, changes in the government's demand for goods and services, or changes in the demand for net exports.

Consider several examples. Suppose consumers were to decrease their spending on all goods and services, perhaps as a result of a recession. Then, the aggregate demand curve would shift to the left. Suppose interest rates were to fall so that investors increased their investment spending; the aggregate demand curve would shift to the right. If government were to cut spending to reduce a budget deficit, the aggregate demand curve would shift to the left. If the incomes of foreigners were to rise, enabling them to demand more domestic-made goods, net exports would increase, and aggregate demand would shift to the right. These are just a few of the many possible ways the aggregate demand curve may shift. None of these explanations, however, has anything to do with changes in the price level.

Changes in aggregate supply. Changes in aggregate supply are represented by shifts of the aggregate supply curve. An illustration of the ways in which the SASand LAS curves can shift is provided in Figures 2 (a) and 2 (b). A shift to the rightof the SAS curve from SAS¹ to SAS² of the LAS curve from LAS¹ to LAS² means that at the same price levels the quantity supplied of real GDP has increased. A shift to the left of the SAS curve from SAS¹ to SAS³ or of the LAS curve from LAS¹ toLAS³ means that at the same price levels the quantity supplied of real GDP hasdecreased 

Like changes in aggregate demand, changes in aggregate supply are not caused by changes in the price level. Instead, they are primarily caused by changes in twoother factors. The first of these is a change in input prices. For example, the price of oil, an input good, increased dramatically in the 1970s due to efforts by oil-exporting countries to restrict the quantity of oil sold. Many final goods and services use oil or oil products as inputs. Suppliers of these final goods and services faced rising costs and had to reduce their supply at all price levels. The decrease in aggregate supply, caused by the increase in input prices, is represented by a shift to the left of the SAS curve because the SAS curve is drawn under the assumption that input prices remain constant. An increase in aggregate supply due to a decrease in input prices is represented by a shift to the right of the SAS curve.

A second factor that causes the aggregate supply curve to shift is economic growth. Positive economic growth results from an increase in productive resources, such as labor and capital. With more resources, it is possible to produce more final goods and services, and hence, the natural level of real GDP increases. Positive economic growth is therefore represented by a shift to the right of the LAS curve. Similarly, negative economic growth decreases the natural level of real GDP, causing the LAS curve to shift to the left.

If it is further assumed that the economy is fully employing all of its resources, the equilibrium level of real GDP, Y^*, will correspond to the natural level of real GDP, and the LAS curve may be drawn as a vertical line at Y^*, as in Figure 1 .

Consider what happens to this situation when the aggregate demand curve shifts to the right from AD¹ to AD², as in Figure 2 

The immediate, short-run effect is that the equilibrium price level increases from P¹, to P², and real GDP increases above its natural level, from Y¹, to Y² . The increase in real GDP is due to the fact that input prices have not yet risen in response to the increase in the price level for final goods; the economy is still operating along the old SAS curve, SAS¹ . Eventually, however, input providers will demand higher prices to reflect the increase in the general price level. Production costs will therefore increase, and the supply of real GDP will be reduced. This is represented by the shift to the left of the SAS curve from SAS¹ to SAS². The end result is a higher price level, P³, at the same, natural level of real GDP, Y¹.

The graphical analysis presented in Figure 2 applies only to the case where there is zero economic growth, and the economy is already at the natural level of real GDP when aggregate demand increases. In the case where the economy is not fully employing all of its input resources and has therefore not yet attained its natural level of real GDP, an increase in aggregated demand—depicted in Figure 3 as a shift from AD¹ to AD²—causes both an increase in the equilibrium price level from P¹ toP², and an increase in the equilibrium level of real GDP from Y¹ to Y² 

In this case, the increase in the equilibrium price level does not necessarily lead to an increase in input prices because the economy is not fully employing all of its input resources. When unemployed inputs are available, input prices do not tend to rise. The result, in this case, is that the SAS curve does not shift left and cancel out the increase in real GDP brought about by the increase in aggregate demand.

The fundamental principle of the classical theory is that the economy is self-regulating. Classical economists maintain that the economy is always capable of achieving the natural level of real GDP or output, which is the level of real GDP that is obtained when the economy's resources are fully employed. While circumstances arise from time to time that cause the economy to fall below or to exceed the natural level of real GDP, self-adjustment mechanisms exist within the market system that work to bring the economy back to the natural level of real GDP. The classical doctrine—that the economy is always at or near the natural level of real GDP—is based on two firmly held beliefs: Say's Law and the belief that prices, wages, and interest rates are flexible.

Say's Law. According to Say's Law, when an economy produces a certain level of real GDP, it also generates the income needed to purchase that level of real GDP. In other words, the economy is always capable of demanding all of the output that its workers and firms choose to produce. Hence, the economy is always capable of achieving the natural level of real GDP.

The achievement of the natural level of real GDP is not as simple as Say's Law would seem to suggest. While it is true that the income obtained from producing a certain level of real GDP must be sufficient to purchase that level of real GDP, there is no guarantee that all of this income will be spent. Some of this income will be saved.Income that is saved is not used to purchase consumption goods and services, implying that the demand for these goods and services will be less than the supply. If aggregate demand falls below aggregate supply due to aggregate saving, suppliers will cut back on their production and reduce the number of resources that they employ. When employment of the economy's resources falls below the full employment level, the equilibrium level of real GDP also falls below its natural level. Consequently, the economy may not achieve the natural level of real GDP if there is aggregate saving. The classical theorists' response is that the funds from aggregate saving are eventually borrowed and turned into investment expenditures, which area component of real GDP. Hence, aggregate saving need not lead to a reduction in real GDP.

Consider, however, what happens when the funds from aggregate saving exceedthe needs of all borrowers in the economy. In this situation, real GDP will fall below its natural level because investment expenditures will be less than the level of aggregate saving. This situation is illustrated in Figure 1 . 

Aggregate saving, represented by the curve S, is an upward-sloping function of the interest rate; as the interest rate rises, the economy tends to save more. Aggregate investment, represented by the curve I, is a downward-sloping function of the interest rate; as the interest rate rises, the cost of borrowing increases and investment expenditures decline. Initially, aggregate saving and investment are equivalent at the interest rate, i. If aggregate saving were to increase, causing the Scurve to shift to the right to S′, then at the same interest rate i, a gap emerges between investment and savings. Aggregate investment will be lower than aggregate saving, implying that equilibrium real GDP will be below its natural level.

Flexible interest rates, wages, and prices. Classical economists believe that under these circumstances, the interest rate will fall, causing investors to demand more of the available savings. In fact, the interest rate will fall far enough—from i toi′ in Figure 1 —to make the supply of funds from aggregate saving equal to the demand for funds by all investors. Hence, an increase in savings will lead to an increase in investment expenditures through a reduction of the interest rate, and the economy will always return to the natural level of real GDP. The flexibility of the interest rate as well as other prices is the self-adjusting mechanism of the classical theory that ensures that real GDP is always at its natural level. The flexibility of the interest rate keeps the money market, or the market for loanable funds, in equilibrium all the time and thus prevents real GDP from falling below its natural level.

Similarly, flexibility of the wage rate keeps the labor market, or the market for workers, in equilibrium all the time. If the supply of workers exceeds firms' demand for workers, then wages paid to workers will fall so as to ensure that the work force is fully employed. Classical economists believe that any unemployment that occurs in the labor market or in other resource markets should be considered voluntary unemployment. Voluntarily unemployed workers are unemployed because they refuse to accept lower wages. If they would only accept lower wages, firms would be eager to employ them.

Graphical illustration of the classical theory as it relates to a decrease in aggregate demand. Figure 2 considers a decrease in aggregate demand from AD₁to AD₂. 

The immediate, short-run effect is that the economy moves down along the SAScurve labeled SAS₁, causing the equilibrium price level to fall from P₁ to P₂, and equilibrium real GDP to fall below its natural level of Y₁ to Y₂. If real GDP falls below its natural level, the economy's workers and resources are not being fully employed. When there are unemployed resources, the classical theory predicts that the wages paid to these resources will fall. With the fall in wages, suppliers will be able to supply more goods at lower cost, causing the SAS curve to shift to the right fromSAS₁ to SAS₂. The end result is that the equilibrium price level falls to P₃, but the economy returns to the natural level of real GDP.

Keynes's theory of the determination of equilibrium real GDP, employment, and prices focuses on the relationship between aggregate income and expenditure. Keynes used his income-expenditure model to argue that the economy's equilibrium level of output or real GDP may not corresPond to the natural level of real GDP. In the income-expenditure model, the equilibrium level of real GDP is the level of real GDP that is consistent with the current level of aggregate expenditure. If the current level of aggregate expenditure is not sufficient to purchase all of the real GDP supplied, output will be cut back until the level of real GDP is equal to the level of aggregate expenditure. Hence, if the current level of aggregate expenditure is not sufficient to purchase the natural level of real GDP, then the equilibrium level of real GDP will lie somewhere below the natural level.

In this situation, the classical theorists believe that prices and wages will fall, reducing producer costs and increasing the supply of real GDP until it is again equal to the natural level of real GDP.

Sticky prices. Keynesians, however, believe that prices and wages are not so flexible. They believe that prices and wages are sticky, especially downward. The stickiness of prices and wages in the downward direction prevents the economy's resources from being fully employed and thereby prevents the economy from returning to the natural level of real GDP. Thus, the Keynesian theory is a rejection of Say's Law and the notion that the economy is self-regulating.

Keynes's income-expenditure model. Recall that real GDP can be decomposed into four component parts: aggregate expenditures on consumption, investment, government, and net exports. The income-expenditure model considers the relationship between these expenditures and current real national income. Aggregate expenditures on investment, I, government, G, and net exports, NX, are typically regarded as autonomous or independent of current income. The exception is aggregate expenditures on consumption. Keynes argues that aggregate consumption expenditures are determined primarily by current real national income. He suggests that aggregate consumption expenditures can be summarized by the equation:

Aggregate Consumption = C + mpc(Y)

where C denotes autonomous consumption expenditure and Y is the level of current real income, which is equivalent to the value of current real GDP. Themarginal propensity to consume ( mpc), which multiplies Y, is the fraction of a change in real income that is currently consumed. In most economies, the mpc is quite high, ranging anywhere from .60 to .95. Note that as the level of Y increases, so too does the level of aggregate consumption.

Total aggregate expenditure, AE, can be written as the equation: AE = A + mpc(Y)

where A denotes total autonomous expenditure, or the sum C + I + G + NX. Different levels of autonomous expenditure, A, and real national income, Y, correspond to different levels of aggregate expenditure, AE.

Equilibrium real GDP in the income-expenditure model is found by setting current real national income, Y, equal to current aggregate expenditure, AE. Algebraically, the equilibrium condition that Y = AE implies that 

In words, the equilibrium level of real GDP, Y*, is equal to the level of autonomous expenditure, A, multiplied by m, the Keynesian multiplier. Because the mpc is thefraction of a change in real national income that is consumed, it always takes on values between 0 and 1. Consequently, the Keynesian multiplier, m, is always greater than 1, implying that equilibrium real GDP, Y*, is always a multiple of autonomous aggregate expenditure, A, which explains why m is referred to as the Keynesian multiplier.

The determination of equilibrium real national income or GDP using the income-expenditure approach can be depicted graphically, as in Figure 1 . This figure shows three different aggregate expenditure curves, labeled AE₁, AE₂, and A₃, which correspond to three different levels of autonomous expenditure, A₁, A₂, and A₃. The upward slope of these AE curves is due to the positive value of the mpc. As real national income Y rises, so does the level of aggregate expenditure. The Keynesian condition for the determination of equilibrium real GDP is that Y = AE.This equilibrium condition is denoted in Figure 1 by the diagonal, 45° line, labeled Y = AE. 

To find the level of equilibrium real national income or GDP, you simply find the intersection of the AE curve with the 45° line. The levels of real GDP that correspond to these intersection points are the equilibrium levels of real GDP, denoted in Figure 1 as Y₁, Y₂, and Y₃. Note that each AE curve corresponds to a different equilibrium level for Y. Note also that each Y is a multiple of the level of autonomous aggregate expenditure, A, as was found in the algebraic determination of the level of equilibrium real GDP.

Graphical illustration of the Keynesian theory. The Keynesian theory of the determination of equilibrium output and prices makes use of both the income-expenditure model and the aggregate demand-aggregate supply model, as shown in Figure 2 . 

Suppose that the economy is initially at the natural level of real GDP that corresponds to Y₁ in Figure 2 . Associated with this level of real GDP is an aggregate expenditure curve, AE₁. Now, suppose that autonomous expenditure declines, from A₁ to A₃, causing the AE curve to shift downward from AE₁ to AE₃. This decline in autonomous expenditure is also represented by a reduction in aggregate demand from AD₁ to AD₂. At the same price level, P₁, equilibrium real GDP has fallen from Y₁ to Y₃. However, the intersection of the SAS and AD₂ curves is at the lower price level, P₂, implying that the price level falls. The fall in the price level means that the aggregate expenditure curve will not fall all the way to AE₃ but will instead fall only to AE₂. Therefore, the new level of equilibrium real GDP is at Y₂, which lies below the natural level, Y₁.

Keynes argues that prices will not fall further below P₂ because workers and other resources will resist any reduction in their wages, and this resistance will prevent suppliers from increasing their supplies. Hence, the SAS curve will not shift to the right as in the classical theory and the economy will remain at Y₂, where some of the economy's workers and resources are unemployed. Because these unemployed workers and resources earn no income, they cannot purchase goods and services. Consequently, the aggregate expenditure curve remains stuck at AE₂, preventing the economy from achieving the natural level of real GDP. Figure 2 therefore illustrates the Keynesians' rejection of Say's Law, price level flexibility, and the notion of a self-regulating economy.

The Taylor rule places emphasis on both price level and business cycle stability. Uses federal funds target rate as policy variable.

The McCallum rule focuses on the rate of growth of the monetary base as policy variable using the quantity theory of money.

 Inflation targeting is a targeting rule that uses open market operations and manages the overnight rate in order to bring expected inflation in line with the target rate. 

Set up chart -- 

Average product / Labor Units / Total Product / Marginal Product / MRP

TP = Avg*(Labor Units)

Marg Product = TP-TP(t-1)

MRP = MP * Price

Product only while MRP > Unit of Labor

Find Required Reserves:

RR = (Demand Deposits)(Reserve Requirement)

Excess Reserves = Required Reserves - Excess Reserves

If S is MORE elastic than D, burden greater on CONSUMERS

If D is MORE elastic than S, burden greater on PRODUCERS

More elastic of the two fucks the other.

Level of technology

Available quantity of labor

Available quantity of capital

If the price of productive inputs increase:

(effect on SRAS and LRAS)

SRAS curve shifts to left/decrease

LRAS (potential real GDP) unaffected

%change in quantity demanded of A / %change in price of B

Positive = Substitutes

Negative = Complements

Absolute value of price elasticity determines whether demand is elastic or inelastic.

d<1 -- Inelastic

d>1 -- Elastic

d=1 Perfectly elastic

2 ways to increase surplus/decrease deficit

Called _____ fiscal policy and how does it affect AD?

Reducing government expenditures, increasing tax rates

Restrictive fiscal policy, decreases AD

Income and substitution effect;

effect of wage increase on both (explain)

Substitution effect leads to increase in labor supplied (less leisure consumed)

Income effect leads to decrease in labor supplied (more leisure consumed)

(1) Consumer wealth

(2) Business expectations

(3) Consumers' income expectation

(4) Capacity utilization

(5) Monetary and Fiscal policy

(6) Exchange rates

(7) Global economic growth

(1) Size of labor force

(2) Human capital/productivity

(3) Supply of natural resources

(4) Stock of physical capital

(5) Level of technology

(1) Input Prices

(2) Labor productivity

(3) Expectations for output prices

(4) Taxes

(5) Subsidies

(6) Exchange rates

(7) ALL FACTORS THAT AFFECT LRAS

(G - T) = (S - I) - (X - M)

Excess of saving over domestic investment - Trade Balance

Calculating a total increase in AD using increase in government spending?

Calculating total increase in AD from tax cut?

Fiscal multiplier formula?

Total Increase in AD = 1/(1-MPC) x Initial Increase in Spending

Amount of Tax Cut = [Increase in AD x (1-MPC)]/MPC

Fiscal Multiplier:

1 / (1 - MPC)

-or- 

1 / [1 - MPC(1-t)]

nGDP = (Quantity produced Year t) x (Prices in Year t)

rGDP = (Quantity produced Year t) x (Base-year prices)

GDP Deflator = (NomGDP / RealGDP) x 100

GDP Deflator = (Current year output@current prices) / (Current year output@base prices)

Spot = Forward rate - Points (ex. Forward = 1.43, a 400 point forward premium)

Spot = 1.43 - (Points/10000) = 1.39