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Midterm 2
Chapters 9-10, 12
87
Economics
Undergraduate 2
03/31/2015

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Term
What is the financial system consisted of?
Definition
The group of institutions in the economy that help match one person's saving with another person's investment.
Term
What is the purpose of the financial system?
Definition
To move the economy's scarce resources from savers to borrowers.
Term
Financial markets
Definition
The institutions through which savers/lenders can directly provide funds to borrowers.
Term
What are the 2 major financial markets we talked about?
Definition
The bond market and the stock market.
Term
Bond
Definition
A certificate of indebtedness that specifies the obligations of the borrower to the holder of the bond.
Term
What is a bond term?
Definition
The length of time until it matures.
Term
Tax treatment
Definition
The way in which the tax laws treat the interest on the bond.
Term
Which type of bond are federal tax exempt?
Definition
Municipal bonds.
Term
Stock
Definition
Represents a claim to partial ownership in a firm and is therefore a claim to the profits that the firm makes.
Term
Equity financing
Definition
The sale of stock to raise money.
Term
Compare bonds and stocks
Definition
Stocks may ofter higher risks, but also potentially higher returns.
Term
What are the most important U.S. stock exchanges?
Definition
New York Stock Exchange, American Stock Exchange, NASDAQ
Term
Financial intermediaries
Definition
Financial institutions through which savers can directly provide funds to borrowers.
Term
What are the two main financial intermediaries we talked about?
Definition
Banks and mutual funds.
Term
What do banks do for spenders and savers?
Definition
Pay depositors interest and charge borrowers slightly higher interest (to profit).
Term
Mutual funds
Definition
An institution that sells shares to the public and uses the proceeds to buy a portfolio of various types of stocks, bonds, or both.
Term
What are the 3 key services provided by the financial system?
Definition
1) Risk sharing
2) Liquidity
3) Collecting and analyzing info
Term
Liquidity
Definition
The ease with which a financial security can be exchanged for money.
Term
GDP formula
Definition
Y= C+ I+ G+ NX
Term
National saving
Definition
The total income in the economy that remains after paying for consumption and government purchases.
Term
Private saving
Definition
The amount of income that households have left after paying their taxes and paying for their consumption.
Term
Private saving formula
Definition
(Y-T-C)
Term
Public saving
Definition
The amount of tax revenue that the government has left after paying for its spending.
Term
Public saving formula (and what each result means)
Definition
T-G
IF: T>G = surplus
G>T = deficit
Term
Loanable funds
Definition
Refers to all income that people have chosen to save and lend out, rather than use for their own consumption.
Term
Where does supply come from?
Definition
Lenders/savers.
Term
Where does demand come from?
Definition
Borrowers.
Term
What does the interest rate stand for?
Definition
The price of the loan.
Term
The interest rate in the market for loanable funds = ______?
Definition
Real interest rate.
Term
How is the real interest rate determined?
Definition
The equilibrium of the supply and demand for loanable funds.
Term
How does tax on interest income affect demand?
Definition
It reduces the future payoff from current saving, reducing the incentive to save.
Term
How does tax decrease affect demand?
Definition
It increases the incentive for households to save at any given interest rate.
Term
If a change in tax law encourages greater saving, the result will be _____________ interest rates and _____________ investment.
Definition
Lower, greater.
Term
What does an investment tax credit do to demand?
Definition
Increases the incentive to borrow, making the demand curve shift right.
Term
If a change in tax laws encourages greater investment, the result will be ______________ interest rates and ____________ saving.
Definition
Higher, greater.
Term
Budget deficit
Definition
When the government spends more than it receives in tax revenues (the difference).
Term
Government debt
Definition
The accumulation of past budget deficits.
Term
What does government borrowing to finance the budget deficit do to the supply of loanable funds?
Definition
Reduces it.
Term
Crowding out
Definition
The fall in investment due to government borrowing.
Term
What does crowding out do to the supply curve?
Definition
Shifts it left.
Term
When the government reduces national saving by running a deficit. the interest rate ____________ and investment ___________.
Definition
Rises, falls.
Term
A budget surplus _________ the supply of loanable funds, ________ the interest rate, and ___________ investment.
Definition
Increases, reduces, increases.
Term
In a closed economy, national saving must = __________?
Definition
Investment.
Term
How is the interest rate determined?
Definition
By the supply and demand for loanable funds.
Term
Rule of 70 formula
Definition
Number of years to double = (70/ growth rate)
Term
Labor productivity
Definition
Refers to the amount of goods and services produced for each hour of a worker's time.
Term
How is a nation's standard of living determined?
Definition
By the productivity of its workers.
Term
How are living standards measured?
Definition
By real GDP per person.
Term
Compounding
Definition
Refers to the accumulation of a growth rate over a period of time.
Term
Factors of production
Definition
The inputs used to produce goods and services.
Term
What are the 4 broad categories of factors of production?
Definition
Physical capital, human capital, natural resources, technological knowledge.
Term
Physical capital
Definition
The stock of equipment and structures that are used to produce goods and services.
Term
Human capital
Definition
The knowledge and skills that workers acquire through education, training, and experience.
Term
Natural resources
Definition
Inputs used in production that are provided by nature.
Term
Technological knowledge
Definition
Society's understanding of the best ways to produce goods and services.
Term
The Solow Model (Production Function)
Definition
A mathematical function that describes the relationship between the quantity of inputs used in production and the quantity of output from production.
Term
Solow Model implicit formula says?
Definition
Y= A*F (L, K, H, N)
The output (Y) depends on the amount of physical capital (K), human capital (H), natural resources (N), the number of workers (L), as well as the state of technology (A).
Term
What does it mean that a production function has constant returns to scale?
Definition
A doubling of all inputs causes the amount of output to double as well.
Term
Explict form of the Solow Model
Definition
Y/L = A*(K/L)^.3 where A=1 and L=2
Term
According to the Solow model, as capital per worker increases, what does output do?
Definition
Increases.
Term
What does the theory of diminishing marginal productivity of capital per worker say?
Definition
As capital increases, so does output, but at a decreasing rate.
Term
According to the Solow Model, what does technological change do to the quantity of output?
Definition
Increases it with the same amount of physical capital.
Term
Diminishing returns says what?
Definition
An increase in the savings rate leads to higher growth only for a while.
Term
The catch-up effect
Definition
The property whereby countries that start off poor tend to grow more rapidly than countries that start off rich.
Term
What are the 5 government policies that raise productivity and living standards?
Definition
1) Encourage saving and investment
2) Encourage investment from abroad
3) Encourage education and training
4) Establish secure property rights
5) Promote research
Term
Foreign direct investment
Definition
Capital investment owned and operated by a foreign entity.
Term
Foreign portfolio investment
Definition
Investments financed with foreign money but operated by domestic residences.
Term
Property rights
Definition
Refer to the ability of people to exercise authority over the resources they own. (Ensures investments are secure).
Term
What happens to economic activity during a recession?
Definition
Normal growth in the production of goods and services doesn't occur.
Term
Classical growth model (Solow)
Definition
Explains how the economy works in the long run.
Term
AD-AS model
Definition
Explains short run fluctuations when the economy is away from long run equilibrium for short periods of time.
Term
How is the economy's output of goods and services measured?
Definition
Real GDP (Y).
Term
What does the aggregate supply curve show?
Definition
The quantity of goods and services that firms choose to produce and sell at each price level.
Term
What are the 3 reasons the aggregate demand curve is downward sloping?
Definition
1) The wealth effect
2) The interest rate effect
3) The exchange-rate effect
Term
How does a lower price level affect spending?
Definition
The interest rate is lower, so investment is higher.
Term
What happens if prices in the U.S. fall, but exchange rate remains the same?
Definition
U.S. exports will rise and the U.S. will import less.
Term
What does a decreased price do to the AD model?
Definition
Curves downward because the quantity demanded (U.S. exports) will be higher than quantity imported.
Term
In the long run, the aggregate supply curve is ___________.
Definition
Vertical.
Term
In the short run, the aggregate supply curve is ____________.
Definition
Upward sloping.
Term
Potential output (Y-bar)
Definition
Occurs when the aggregate supply curve is vertical, at its natural rate of output.
Term
L-bar
Definition
The amount of labor force employed when the actual rate of unemployment equals the sum of frictional and structural unemployment.
Term
What are the 3 reasons the aggregate supply curve slopes upward in the short run?
Definition
1) Sticky-wage theory
2) Sticky-price theory
3) Misperceptions theory
Term
Sticky wage theory
Definition
Nominal wages are slow to adjust, or are "sticky" in the short run, making production at a lower price level less profitable.
Term
Sticky price theory
Definition
The prices of some goods and services adjust sluggishly in response to changing economic conditions.
Term
Misperceptions theory
Definition
Changes in the overall price level temporarily mislead suppliers about what is happening in the markets in which they sell their output.
Term
Stagflation
Definition
A period of recession and inflation.
Term
What happens during a period of stagflation?
Definition
Output falls and prices rise.
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