Final Exam Review Macroeconomics

Final Exam ReviewMacroeconomics

Econ EB222 WIN 2013

Inst Shan A GaribMohawk College

Final Exam Macroeconomics

Date Monday April 15th 2013Time 1230pm ndash 200pm

In-Class

Review ALL Quizzes given in class

Consumption Investment and Consumption Investment and the Multiplier Chapter 9the Multiplier Chapter 9

Consumption Consumption (Continued)(Continued)

bull The consumption functions statesndashAs income rises consumption (C)

rises but not as quicklyIncome = Consuption + Saving + taxes

Y = C + S + t and Disposible Income = Consuption + Saving

Yd = C + S or Yd = Y - tTherefore consumption varies with disposable income (DI)

Marginal Propensityto Consume (MPC)

MPC = in Consumption

in Income

CHANGECHANGE

CHANGECHANGE

45

$1000

$1000

$6000

$6000

C

$6000

5700

$6000

Saving = $300

$2700

$3000

Dissaving = $300

$2700

Saving = - $300

YGDP0 = $10000bn(C0) is $8600 bn MPC = 025 Note In mathematics Dx = ldquoChange inrdquo

At a Y GDP1 of $9000bn how much would be saved (Assume there is no taxes in the economy)

DxC = MPC x DxDI

DxDI = $9000bn - $10000bn = -$1000bn

DxC = 025 x -$1000bn = -$250bn

Since C0 was $8600bn the DxC of -$250bn will bring consumption down to C1 = $8350bn (= $8600bn - $250bn)

If S = DI ndash C1

At a national income of $9000bn(S) = $9000bn of DI - $8350bn of C = $650bn

9

Fiscal Policy and the Public Debt

Chapter 10amp11 Instructor Shan A Garib WIN 2013

Expansionary fiscal policybull If budget is initially balanced moves it towards

a budget deficit during recessionbull Increased government spending (G) andor

lower taxesbull Aim to stimulate economic activity and to move

the economy out of a recessionbull AD = C + I + G + (X-N)

bP2

LRAS

Pric

e Le

vel

P1

Y2

AD1

AD2

Y1

c

SRAS

P2

LRAS

Pric

e Le

vel

P1

AD1

AD2

c

SRAS1

Y1

d

SRAS2

Higher P and wages costs SRAS shift left

Letrsquos say there is a war and the government buys planes and guns

ldquoGrdquo goes up

b

Contractionary fiscal policybull If budget is initially balanced moves it towards

a budget surplus during an inflationary periodbull Decreased government spending andor

higher taxesbull Aim to control demand and reduce

demand-pull inflation

cP2

LRAS

Pric

e Le

vel

P1

AD2

AD1

b

SRAS

cP2

LRAS

Pric

e Le

vel

P1

AD2

AD1d

SRAS2

Y2 Y1

b

SRAS1

Lower P and wages costs SRAS shift right

Letrsquos say there is a war and the half the population dies ldquoCrdquo goes down

Government Budgets and Financesbull Governmentrsquos budget balance is amount of revenue it

recieves minus its spending

Balanced budget is when Revenues = Spending

0 = Revenue ndash SpendingBudget Surplus is when Revenues gt Spending

0 gt Revenue ndash SpendingBudget Deficit is when Revenues lt Spending

0 lt Revenue ndash Spending

13

Money and the Banking SystemChapter 12

Instructor Shan A Garib WIN 2013

Defining Money (contd)

bull The transactions approach tomeasuring money M1

1048707 Currency1048707 Deposits you can write a check for1048707 Travelerrsquos checks

Defining Money (contd)

bull The liquidity approach M2 is equal toM1 plus1 Savings amp time deposits2 Balances in retail money marketmutual funds3 MMDAs

16

Money Creation and Deposit Insurance

Chapter 13 Instructor Shan A Garib WIN 2013

bull Reserves

ndash deposits held by BOC for chartered banks like BMO plus their vault cash

Reserves

Reserves

bull Legal Reserves

ndash Anything that the law permits banks to claim as reservesmdashfor example deposits held at BofC and vault cash

Reserves

bull Required Reserves

ndash The value of reserves that a depository institution must hold in the form of vault cash or deposits with the BofC

Reserves

bull Required Reserve Ratio

ndash The percentage of total transactions deposits that the Fed requires depository institutions to hold in the form of vault cash or deposits with the Fed

Required reserves = Demand deposits Required reserve ratio (M)

Reserves

bull Excess Reserves

ndash The difference between legal reserves and required reserves

Excess reserves = Legal reserves ndash Required reserves

The Money Multiplier (contd)

Actual changein the money

supply= Actual money

multiplierChange in

total reserves

Potential money multiplier = 1

Required reserve ratio

The Money Multiplier (contd)

bull Example

ndash Fed buys $100000 of government securities

ndash Reserve ratio = 10

Potential changein the money

supply= $100000 = $1000000x

1

10

Scotia Bank has NO excess reservesBank of Canada purchases $10000 of bonds with a check from a man named Mr HarperMr Harper deposits this check into his account in Scotia BankNOTE If the BofC buys bonds from a chartered bank eg CIBC then there will be NO change in Demand Deposits because that money is not available to the public If the required reserve ratio (M) is 25The maximum amount of money Scotia can loan out What is the TOTAL potential change in the money supply Excess reserves = Reserves - Required Reserves

But Required Reserves = M Demand Deposits Required Reserves = 025 $10000

Required Reserves = $2500Therefore Excess reserves = Reserves - Required Reserves Excess reserves = $10000 - $2500

= $7500Resultant change in the money supply the banks can create

= 1m x Dx(Excess Reserves)

= (125) x $7500 = 4 x $7500 = $30000Then the TOTAL change in money supply is

= initial demand deposit + Dx(money supply banks can create) = $10000 + $30000 = $40000

BMO has $160 million of reservesThe M = 20 The Bank of Canada then lowers M to 16 How much can BMO lend out BMO is ALL LOANED UP ie it cannot make any additional loans so it has 0 excess reserves

Excess Reserves = Reserves - Required Reserves

Since excess reserves = 0 then

reserves = required reserves = $160 million

Required Reserves = M x Demand Deposits

$160 million = 20 x Demand Deposits

$160 million20 = Demand Deposits

$800 million = Demand Deposits By lowering the required reserve ratio to 16 required reserves will be reduced and excess reserves will increase as some required reserves are converted into excess reserves Now

Required Reserves = 16 x $800 million = 16 x $800 million

= $128 million Excess Reserves = Reserves - Required Reserves = $160 million - $128 million = $32 million the amount BMO may now lend out