Monday, February 11, 2008

Homework 1

DEFINITION TERMS

Aggregate Demand Relation[1]
The aggregate demand relation captures the effects of the price level on output. It is derived from the equilibrium conditions in the goods and financial market. This relation implies that the level of output is a decreasing function of the price level. It is represented by a downward sloping curve called the aggregate demand curve.












Animal Spirits[2]
This is a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.


Bank Run[3]
This is a kind of crisis where a large portion of a bank’s customers withdraw their money in a short time because they feel that there is a problem with the bank’s solvency.

In January 2007, Zhonghua Bank in Taiwan suffered one of the most serious bank runs in years. In one day, about 50 billion Yuan was withdrawn by customers.


Bond[4]
A bond is a debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity.

There are different kinds of bonds, such as: fixed rate bonds which have a coupon that remains constant throughout the life of the bond and floating rate notes which have a coupon that is linked to a money market index, such as LIBOR, for example three months USD LIBOR + 0.20%.

The interest earned on a bond investment is known as the bond yield.

Yield on a 30-Year Treasury Bond 1994-2005



Capital Account[5]
The capital account records international transactions involving foreign assets and liabilities. For example, US residents purchase foreign securities to earn a higher rate of return and to diversify their portfolios. US capital flows out when Americans buy foreign assets. Foreign capital flows in when foreigners buy US assets.

In 1995 America developed a capital account problem as a result of over-investment by foreigners.


Debt to GDP Ratio[6]
A measure of a country's federal debt in relation to its gross domestic product (GDP). By comparing what a country owes and what it produces, the debt-to-GDP ratio indicates the country's ability to pay back its debt. The higher the debt-to-GDP ratio, the less likely the country will pay its debt back, and the higher its risk of default.

America’s debt to GDP ratio from 1940 - 2004




Effective demand[7]
This is when the consumers desire to buy something is backed up by a willingness and an ability to pay for it.

The notion that the actual demand for aggregate output in the macroeconomy is based on the actual income or other existing economic conditions and not on income and conditions existing in equilibrium.


Deflation[8]
The price level of a market decreases under the general level during a period of time.

During The Great Depression 1930-1933, the rate of deflation was approximately 10 percent per year.


Consumption function[9]
It is the function that used to calculate the consumption in an economy. It determines how much of people’s disposable income they will spend at different levels of income.
The simple consumption function is shown as the linear function:

C = c0 + c1Yd

where C = total consumption, c0 = autonomous consumption (c0 > 0), c1 = the marginal propensity to consume (0 < yd =" disposable">







Consumer Price Index[10]
The Consumer Price Index (CPI) is designed to measure the change in the average level of prices paid for consumer goods and services by all private households and foreign visitors to Ireland. The CPI is the official measure of inflation in Ireland.



Investment Function[11]
It is a function that used to calculate the investment in an economy.
Such as I=I(r)which represent the relation between interest rate and the total investment.


Fiscal Expansion[12]
This is when the economy is stimulated towards achieving macroeconomic objectives such as full employment, sustained economic growth and price level stability by setting and changing taxes, making transfer payments, and purchasing goods and services.

For example, by increasing government spending or by reducing taxes the government can shift the aggregate demand curve rightward in order to expand real output.


GDP Deflator[13]
The GDP deflator measures changes in the average price of an economy’s output. This is a broader measure than the consumer price index and covers goods and services sold to businesses as well as households. The formula used to calculate the deflator is:
Nominal GDP * 100
Real GDP

Economy-wide price levels have increased at a higher rate in Ireland than in both the EU and the OECD since 1997.



Imports[14]
Products are brought from one country to another so that they can be sold there.

China imported lots of goods from the EU in 2006 –
Germany €27 billion (43% of total imports)
France €8 billion (13% of total imports)
Italy €6 billion (9% of total imports)


Monetary Contraction[15]
Monetary contraction is the reduction in the quantity of money and or volume of spending in the economic system.

For example, when the Irish government increases income tax it is taking part in monetary contraction.


Nominal GDP[16]
Nominal GDP is a gross domestic product figure that has not been adjusted for inflation.

For example, in 2006 Ireland had a nominal GDP per capita of $44500.


Propensity to Consume[17]
This is the proportion of total income or of an increase in income that consumers tend to spend on goods and services rather than to save.
For example if I earn €100 in a week and I spend €80 of it then my marginal propensity to consume would 0.8. The €20 I didn’t spend is my marginal propensity to save i.e. 0.2 or 1-MPC.


Short Run[18]
In macroeconomics, the short run is a period of time in which wages and prices are inflexible and resource markets are not in equilibrium.

For example, if a government or central bank increases the interest rate in a country then the short run will last until the effects are evident in wages and prices especially housing prices i.e. when they began to decrease. When the ECB increased the interest rate there was a period of time before the effects were visible.


Real Exchange Rate[19]
A real exchange rate between two countries is calculated as the product of the nominal exchange rate and relative price levels in each country, i.e. it is the nominal exchange rate that takes the inflation differentials among the countries into account

For example, the real exchange rate between the Dollar and the Brazilian Real at the moment is 1USD to 1.7790 BRL, this has taken into account the inflations levels in the respective countries.


Trade Surplus[20]
A positive balance of trade, i.e. exports exceed imports.

Or example, for the month of February China had a trade surplus of $23.76billion.


STEADY-STATE SOLUTION QUESTION

The stationary state flow of aggregate income is:

Y* = G
θ

If for example, Government expenditure (G) is €20 million and the tax rate (θ) is equal to 20%, the aggregate income (Y*) is equal to:

20
0.20

=

€100 million

However, if the tax rate increases to 30%, the steady state value of Y* will decrease to:

20
0.30

=

€66.7 million

This is because:

1. An increase in the tax rate means that consumers will have to pay higher taxes on their income.

For example if consumers are earning €1000 at a 20% rate of tax, the tax they pay is equal to:
T = θ * Y
200 = 0.20 * 1000

However, if the tax rate increases to 30%, they will have to pay taxes of:

300 = 0.30 * 1000

2. As a result of increased taxes consumers will have less disposable income

Disposable income: YD = Y – T

At a 20% tax rate consumers’ disposable income is equal to:

800 = 1000 – 200

However, at a 30% rate their disposable income is equal to:

700 = 1000 – 300

3. A reduction in disposable income will inevitably lead to a decline in consumption of consumers and thus the national income will also decline since
Y = C + I + G

4. The national income will decline until it reaches the steady-state solution of €66.7 million as per this example.





[1]http://www2.widener.edu/SBA/econdept/ch07-part%202-4e-sp07-agg%20dem.ppt#1
[2] http://distance-ed.bcc.ctc.edu/econ100/ksttext/keynes/keynes.htm
[3]http://www.gusu.org/catalog.asp?tags=%E9%93%B6%E8%A1%8C%E6%8C%A4%E5%85%91
[4] http://en.wikipedia.org/wiki/Bond_(finance)
http://www.marketoracle.co.uk/Article1384.html
[5] McEachern W. V (2006) Macroeconomics: A Contemporary Introduction, Thompson South-Western: UK
http://www.jubileeinitiative.org/BePrepared-CapitalAccountProblem.htm
[6] http://www.investopedia.com/terms/d/debtgdpratio.asp
[7] http://en.wikipedia.org/wiki/Effective_demand
[8] http://en.wikipedia.org/wiki/Deflation_(economics)
[9] http://en.wikipedia.org/wiki/Consumption_function
http://tutor2u.net/economics/content/topics/consumption/consumption_theory.htm
[10] http://www.cso.ie/releasespublications/documents/prices/current/cpi.pdf
[11] http://en.wikipedia.org/wiki/Investment
[12] Parkin, M. (2006) Economics, Pearson Education: US
[13] http://www.forfas.ie/ncc/reports/ncc_annual_05/ch03/ch03_03.html
[14] http://finance.sina.com.cn/stock/t/20071128/02401819156.shtml
[15] http://www.gold-eagle.com/gold_digest_03/
[16] http://www.investopedia.com/terms/n/nominalgdp.asp
[17] http://www.britannica.com/eb/article-9061553/propensity-to-consume
[18]http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=short%20run,%20macroeconomics
[19]http://www.rba.gov.au/PublicationsAndResearch/Bulletin/bu_nov01/bu_1101_2.pdf
[20] http://www.investorwords.com/5028/trade_surplus.html

1 comment:

Stephen Kinsella said...

Really liked the numerical example for the y=G/theta question, well done overall.