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Details Title: Keynesian Cross, IS-LM Description: UNIT II Total Flash Cards: 77 Created: 03/20/2007 18:08:33	To study from this set of flash cards, or to create your own your own study flash cards, register HERE. If you are already a registered user, CLICK HERE.
Cards Term According to Keynes, the labor market is characterized by what (3)? what's the result? Definition -characterized by inflexibility of wages, imperfect information, and imperfect mobility -a positively sloped supply curve (not vertical AS) & therefore effective gov't policy aimed at increasing real output Term what 3 things did keynes criticize/believe classical model would fail? (3 things) Definition 1) labor market 2) loanable funds market 3) velocity Term Why did keynes criticize the loanable funds market? Definition -produced insufficient aggregrate demand due to excessive long term savings, thus savings is not always matched by investment -savings & consumption are not functions of interest but of INCOME Term Keynes believed that Velocity may be ________________________________. Definition unstable causing the effects of monetary policy to be unpredictable Term Keynes said it was not the interest return that was the primary motivation to save but _________________________. Definition ...the income level that would determine the level of savings Term Keynes believed that investment is largely __________________ and therefore would not respond much to short-run changes in ____________. Definition -long term -interest Term Keynes believed investment is function of expected ________. Definition profit Term during great depression, according to classical model, the surplus of laborers should have done what? Definition dropped the wages dramatically (if wages dropped then employers would be able to hire more laborers) Term keynes found that labor market is not free of all constraints to wage flexibility. WHY? Definition -Unions with long term contracts -outside contracts -legal barriers (ie min wage) -these things keep wage above equilibrium Term in the labor market, according to keynes, an increase in employment (demand curve shifting to right) increases what? Definition -total output -quantity supplied on aggregrate supply curve -THUS AS curve is pos. sloped. higher prices results in higher output Term How can demand shift according to keynes? what does that result in? Definition -gov't spending or investment -higher output and more employment Term According to Keynes, the myriad of prices that consumers face would make it impossible for consumers to realize ________________. Definition ...the actual effect of a change in the general price level on their real wage. Term What's the "money illusion"? what's the significance? Definition -people being fooled into thinking they are better off b/c of higher dollar wages when really prices are rising at same amount of wages -if gov't raises prices and wages, ppl will work more and raise work effort and real output Term classical model assumes savings is a function of...? where keynes assumed savings is a function of ...? Definition -the interest rate (ppl save depending on how much return they will get) -income level Term keynes believed consumption is a function of...? as income rises, ppl will consume some stable percentage of it and _________? Definition income save the rest Term keynes believed that savings does not equal investment. That there is a permanent ________ in savings & ____________ of demand. Definition -surplus\ -demand Term what did keynes believe about ppl holding money? Definition -they would hold for other reasons that to pay bills - if ppl want to hold less, they would purchase other assets or goods Term in classical model, a change in Ms (money supply) would change ......? but if velocity was unstable, then it would .....? Definition would change P (price level) proportionally. -not be proportional Term keynes believed this was important to macro performance Definition DEMAND side Term what makes up demand side? Definition Consumption, investment, and gov't spending Term KEYNES: if economy is suffering low output or unemployement, the cure is to ___________________. Definition boost a component of demand (C,I,G) to increase businesses to produce Term KEYNES: easiest way to to influence demand is...? Definition fiscal policy: raising/lowering taxes Term KEYNES: what is the consumption equation? Definition C = a + bY Term KEYNES: the "b" term in Consumption equation is what? Definition the rate at which consumption rises as income rises Term KEYNES: income is compiled of what two things? Definition Savings and consumption Term in the keynsian cross, what does the 45 degree line represent? Definition all possible points where output is equal to demand (C,I,G) Term in the keynesian cross, an increase in what increases equilibrium output & income by more that the increase in demand? Definition exogenous demand Term KEYNES: an increase in demand by investors induces... Definition greater demand by consumers Term multiplier measures how much of a change in income and output is caused by... Definition a change in investment (or by any change in C,I, or G) Term the multiplier tells us that for any change in investment or shift of the consumption line, output and income will ____________________. Definition change by ___ times the change in investment or consumption Term in the Keynesian cross model, what is included in "A"? Definition consumption when income equals 0, investment, government spending. Term what is the keynesian cross equation? Definition Y = a + b(Y-T) + I + G Term What compromised the Keynesian Cross? Definition Stagflation: combination of inflation & unemployment Term What variables did the Keynesian model lack? (5) Definition Price variable, money supply and demand, the interest rate, lack of production Term what is inherent in the keynesian model? Definition the assumption that supply is perfectly elastic/responsive Term the IS LM model adds what to the keynesian cross? Definition interest rate Term what is interest rate? Definition the price paid to borrow money or the price received from "sellling" money by loaning it directly or indirectly through financial intermediaries (ie banks) Term How does the FED control the money supply? (3) Definition 1) reserve requirement 2) Open Market Operations 3) the discount rate Term what is the reserve requirment? Definition -the most powerful tool that the fed uses to control the money supply -indicates the percentage of deposits that must be held in reserve Term how do you find the total expansion of a deposit with the reserve requiremnt? Definition (1/rr) x deposit Term What are OPO? Definition -when the Fed buys and sells bonds (Treasury bills) through its NY branch. -to increase Ms: buys bonds (can be big/little increase depending on rr) -to decrease Ms: sells bonds Term What is the rate of interest charged by the Fed to borrowing banks? Definition the Discount Rate Term What happens when the Fed raises the discount rate? Definition banks reduce borrowing and money supply decreases Term what happens when the Fed lowers the discount rate? Definition banks borrow more and thus increase money supply Term what is transaction demand for money? in is-lm how is money demand related to level of income Definition -hold money in anticipation of paying bills -money demand is pos related; as income rises so does the demand for money for transactions Term how does the interest rate and money demand relate? in what two ways? Definition NEG related: (1) interest goes up, money demand goes down b/c interest is oppurtunity cost (2) speculative demand; if interest goes up, ppl expect to go down and thus have cap gain on bonds thus holding less money when interest goes up Term what is another term for speculative demand? Definition liquidity preference Term what are bonds? Definition securities that have some unique features; they're issued at a fixed maturity value and pay a fixed dollar return Term if interest rate goes up, what happens to price of bonds? Definition they go down Term monedy demand is compromised of what two things? how does it look in an equation? Definition 1) money demand is positively related to income 2) money demand is neg. related to interest Md=fY + g - hr Term according to money demand, what is a change in demand and what is a change in quantity demanded? Definition -change in demand: moving from one income to the next -change in quantity demand: changing the interest rate Term why is the LM curve pos sloped? Definition as Y goes up, Md shifts to the right, and equilibrium interest rate goes up; in other words, as income rises, Md shifts to right, and equilibrium interest rises Term what happends when Ms>Md? Definition have more money than you want, so buy bonds, then the price of bonds increases, and interest rate falls Term what happens when Md>Ms? Definition want to hold more money, so sell bonds, then price of bonds goes down, thus interest rate goes up Term is Ms greater or less than Md when point is above LM curve? Definition Ms>Md. thus buy bonds, PB goes up, interest goes down Term what does is mean when a point is below LM curve? Definition Md>Ms. thus sell bonds, price of bonds go down, interest goes up Term what does keynesian and classical thinking share about monedy demand? Definition money demand goes up with income, although they disagree on the stability of Velocity (V). Term What does the LM curve show? Definition all possible equilibrium interest rates at different income levels; it is made up of all the points where money supply equals money demand Term in the goods market, how many components of demand are there and what are they? Definition 3; consumption, investment, government spending. Term what is the IS curve equation? Definition Y = a+bY + c-dr + G c-dr because as interest rises, investment falls Term what does the IS curve represent? Definition equilibrium incomes at different possible interest rates in the goods market Term why does the IS curve neg. sloped? Definition b/c as interest falls, investment(and other spending) rises, and so equilibrium income rises Term What are the 5 statements of the IS LM model? Definition 1)Md is positively related income 2)Md is neg. related to interest 3)Fed controls Money supply 4)consumption is pos. related to income 5)investment(all expenditures) are neg. related to interest rate Term if expenditures exceed income, where does that pt. lie and what happens? Definition below IS curve; too much demand thus Y increases; interest is low, thus ppl spend more than income/output Y Term If a point is above IS curve, what does it mean and what happens? Definition means there is too little demand, (interest is high thus expenditures are less than Y), and Y decrease Term Algebraically, how would you find equilibrium in IS-LM model? Definition solve for r in both equations, then equal each other to solve for Y Term when point out of equilibrium in IS-LM model, what adjusts first? Definition interest rate will adjust first, where money demand would equal money supply. the point will then never be far off of the LM curve Term the LM curve will shift parallely if what happens? Definition change in g or Ms Term what happens to the LM curve, if Money supply increases,? decrease? Definition Ms increases: the curve parallely shifts down, Y increases Ms decreases: shifts up parallely, Y decreases Term what happens to LM curve if g (the intercept when r=0) increases? Definition increases: LM shifts left b/c interest rises decrease: LM shifts right b/c interest decreases Term what causes a parallel shift in the IS curve? Definition A, the autonomous variables, which include a, c, and G Term if government spending is increased in IS-LM model, what happens? Definition income goes up, Md rises, interest then goes up, then investment goes down, and then incomes goes DOWN! CROWDING OUT!! Term in the IS-LM model, what two markets does the interest rate have an impact on? Definition 1)money market by influencing Md 2)goods market by influencing I Term when the autonomous variable, g, changes in the LM model, income levels do not change, but what does? Definition MONEY DEMAND; so if g increases, then the equilibrium interest rate will be higher at each income level and the LM curve shifts to the left/up. when that happens then in the IS-LM model, Y decrease. Term what two things produce a parallel shift in the LM curve? Definition change in 'g' and change in Ms Term a decrease in g produces the same effects as an increase in ...? Definition MONEY SUPPLY; equilibrium interest rate drops at each income level, the LM curve shifts down, which increases Y in the IS LM model. Term an increase in money supply affects classical in what ways? is-lm? Definition -classical: increase Prices -is-lm: increase in real output