1. Aggregate Demand relation
Aggregate Demand refers to the total amount that all consumers, business firms, government agencies, and foreigners wish to spend on all final goods and services at a given time and price level. It is often called effective demand or abbreviated as ‘AD’. (http://en.wikpedia.org/wiki/Aggregate_demand)
(William J. Baumol and Alan S. Blinder. 1997. “Macroeconomics Principles and Policy”. pp143)
The following equation clearly exhibits the relationship between aggregate demand and its relevant factors: AD= C + I + G + (X-IM)
Where C stands for consumption, I symbols investment, G relates to government purchases of goods and services and (X-IM) represents net exports, all of which positively correlate with AD: If C increases, it means the total demand for all consumer goods and services would rise; If I (the purchase of some new, physical assets) goes up, it will lead to additional demand for newly produced goods and greater productive capacity; If G is enhanced, employment should be given a positive injection and the ripple effect (boost) also spreads to other industries although to some extent it may squeeze certain part of private investment; If the total demand for goods and services originating beyond borders minus domestic desire for goods and services outbound is fortified, AD will also increase. Besides another important factor--- price level must be taken into account to determine the level of aggregate demand, that is, the higher the price level the lower the aggregate expenditure is.
Graphical Example:
Aggregate Demand Curve
Along the curve---if price level changes Shifting the curve---if C, I, G, X-IM change
Source:(http://www.amosweb.com/cgi-in/awb_nav.pl?s=wpd&c=dsp&k=aggregate%20de%20mand%20curve)
2. Animal Spirits
Animal Spirits are a particular sort of confidence “naïve optimism” towards economic prosperity given by Keynes. He meant in particular for entrepreneurs, “the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death”.
(http://www.economist.com/research/Economics/alphabetic.cfm?letter=A)
A better example in economic area is the overreaction of people in stock market. Here in practical world one of the assumptions in economics “rational investors” seems to be deviated. Herd effect and follow-up tendency intensify blind expectations of price movements for equities which would result in bubbles and severe devastation to the whole economic. As it’s well-know, in 2000 the collapse of American network stocks rightly demonstrates the irrationality of people including both individuals and government and investors’ over-optimistic attitudes towards technology.
3. Bank Run
It refers to a situation when the customers of a bank fear that the bank would become insolvent, they rush there to take out their money as quickly as possible to avoid losing it, which would spread quickly around.
(http://economics.about.com/cs/economicsglossary/g/bank_run.htm)
It is a game playing between depositors. Actually some of them have no need for extra money but to avoid losing it they swarm in the banks for withdrawals which would intensify the crisis. In general this kind of bank run is always associated with currency crisis and credit crisis.
For example: American S&L Crisis in 1980s’ which began with S&L’s golden period as houses demand was strong and ended with its bankruptcy which was in contagion with other financial institutions quickly.
4. Bond
A bond is a fixed interest financial asset issued by governments, companies, banks, public utilities and other large entities which attracts investors by promise to repay the principal along with interest (coupons) on a specified date (maturity).
Compared with equity, two characteristics stands out as: a. The buyer does not gain any kind of ownership rights to the issuer. b. A bond holder has a greater claim on an issuer’s income than shareholder in the case of financial distress. The yield from a bond is made up of three components: coupon, interest, capital gains and interest on interest.
(http://www.investorwords.com/521/bond.html)
5. Capital Account
It is one of two primary components of the balance of payments, which is referred to as the financial account in the IMF’s definition.
Capital account= Increase in foreign ownership of domestic assets- Increase of domestic ownership of foreign assets (Foreign direct investment)- Portfolio investment+ Other investment
(http://en.wikipedia.org/wiki/Capital_account)
6. Debt to GDP ratio
It is a measure of a country’s federal debt in relation to its GDP, which indicates the country’s ability to pay back its debt. If a country were unable to pay its debt, it would default, which could cause a panic in the domestic and international markets. The high the debt-to-GDP ration, the less likely the country will pay its debt back and the higher its risk of default.
(http://www.investopedia.com/terms/d/debtgdpratio.asp)
Suppose country A has such ratio of 1, country B with 1.5. Undoubtedly, we can say the former is positioned better in their debt payment than the later although situations are disadvantageous for both countries.
Latin American debt crisis in 1982 is a good example for further explanation: For the reason of frustrating integration of regional markets, imbalance of foreign trade, severe dependence on outside funds and technologies, no timely structure and development mode adjustment, GDP of most countries located in Latin America grew negatively with great gap between borrowing amount. It is well-known the result was devastating.
7. Effective Demand
Effective demand refers to the simple economic idea that says that it's not enough to want something such as food or luxuries. One must also have money or other assets (purchasing power) or some product to sell in order to make that demand effective.
Source : (http://www.investordictionary.com/definition/effective+demand.aspx)
Example: A business man has to decide at the beginning of the week the number of workers to hire sufficient to bring his goods to market at the weekend. The workers hired by the businessman work throughout the week and are paid on a Friday for their efforts. On the weekend the employees as well as other customers, come to the market to purchase the goods from the businessman using the income they have earned. Ideally the businessman expects to sell the last product to the last customer if his expectations regarding demand are met.
8. Deflation
Deflation is a decrease in the general price levels over a period of time.
Example: One famous historical example of deflation was the Great Depression when the American economy collapsed as a result of a variety of strains, and a world-wide depression was triggered. People in the middle classes lost their jobs and stopped buying products. People in the upper classes had to cut back on their consumption of luxury products. As a result, there was a decreasing demand for products. Manufacturers cut prices with the hope that more people would buy their products, and fired people to pay for the drop in prices. Essentially as prices dropped, the same amount of money could buy more goods.
9. Consumption Function
In economic terms this function calculates the amount of total consumption in an economy. In essence the consumption function says that the amount people spend depends on their income, and that as income increases, so does consumption.
Source:(http://en.wikipedia.org/wiki/Consumption_function).
Example: Increased levels of affluence experienced in Ireland during the Celtic Tiger years enabled Irish people to spend much more on luxury items than ever before in the country’s history.
10. Consumer Price Index:
This is an index measuring the average price of consumer goods and services purchased by households.
Graphical example:
11. Investment Function:
This economic concept explains how changes in national income induce changes in investment patterns in the national economy.
istorical Example: After terrorists leveled the World Trade center in 2001 business expectations would have decreased significantly. This resulted in a decrease in planned income and investment decreased at every level of income. This would have had the effect of a shift in the investment function graph downwards.
12. Fiscal Expansion:
This is the increase of government expenditures or budget.
Example: Essentially a fiscal expansion is the raising of aggregate demand through one of two means. Firstly, a government can increase purchases but keep taxes the same, this will increase demand directly. Secondly, if the government cuts taxes or increases transfer payments, people’s disposable income rises, and they will spend more on consumption. This rise in consumption will, in turn, raise aggregate demand.
13. GDP Deflator:
This is the measure of the change in prices of all new, nationally produced, final goods and services in an economy.
Numerical Example: For a farmer, we could define a “unit” to be a crop with a specific level of output, size, produce etc. A price deflator of 200 means that the current-year price of this crop is twice its base-year price - price inflation. A price deflator of 50 means that the current-year price is half the base year price - price deflation.
14. Imports:
In reference to international trade, these are goods brought into one country from another (http://www.investopedia.com/terms/i/import.asp).
Example:
This economic concept explains how changes in national income induce changes in investment patterns in the national economy.
istorical Example: After terrorists leveled the World Trade center in 2001 business expectations would have decreased significantly. This resulted in a decrease in planned income and investment decreased at every level of income. This would have had the effect of a shift in the investment function graph downwards.
12. Fiscal Expansion:
This is the increase of government expenditures or budget.
Example: Essentially a fiscal expansion is the raising of aggregate demand through one of two means. Firstly, a government can increase purchases but keep taxes the same, this will increase demand directly. Secondly, if the government cuts taxes or increases transfer payments, people’s disposable income rises, and they will spend more on consumption. This rise in consumption will, in turn, raise aggregate demand.
13. GDP Deflator:
This is the measure of the change in prices of all new, nationally produced, final goods and services in an economy.
Numerical Example: For a farmer, we could define a “unit” to be a crop with a specific level of output, size, produce etc. A price deflator of 200 means that the current-year price of this crop is twice its base-year price - price inflation. A price deflator of 50 means that the current-year price is half the base year price - price deflation.
14. Imports:
In reference to international trade, these are goods brought into one country from another (http://www.investopedia.com/terms/i/import.asp).
Example:
Data from http://www.uschina.org/statistics/tradetable.html15. Monetary Contraction:
A reduction in the size of the money supply. A central bank can implement contractionary policy by reducing the size of the monetary base, which directly reduces the total amount of money circulating in the economy (http://en.wikipedia.org/wiki/Contractionary_monetary_policy).
Example: Contractionary monetary policy can have the effect of reducing inflation by reducing upward pressure on price levels. The ECB’s mandate is to control inflation (the Fed has a dual mandate of price stability and full employment). Under renewed pressure by the Federal Reserve’s action to recently cut its base rate Jean Claude Trichet, ECB President, acknowledged that there were downside risks to growth, but added, “Particularly in demanding times of significant market correction and turbulence, it is the responsibility of the central bank to solidly anchor inflation expectations to avoid additional volatility in already highly volatile markets.” Consequently, the ECB has left its main interest rate unchanged at 4% since June 2007.
16. Nominal GDP:
A gross domestic product (GDP) figure that has not been adjusted for inflation (http://www.investopedia.com/terms/n/nominalgdp.asp).
Example: If the nominal GDP figure has increased by 8% but inflation has been 4%, the real GDP has only increased 4%.
17. Propensity to consume:
This is an inclination to spend what one earns on the consumption of goods and services, as opposed to being saved. Marginal propensity to consume (MPC) represents the proportion of an aggregate raise in pay that is spent on the consumption of goods and services. (http://www.investopedia.com/terms/m/marginalpropensitytoconsume.asp).
Example: Suppose someone receives a bonus of €500. If they decide to spend €400 of this marginal increase in income on a new watch, their marginal propensity to consume will be 0.8 (€400 divided by €500).
18. Short run:
The concept of the short-run refers to the decision-making time frame of a firm in which at least one factor of production is fixed. Costs which are fixed in the short-run have no impact on a firm’s decision.
Average cost per unit is minimised at a range of output between 350 and 400 units. Thereafter, because the marginal cost of production exceeds the previous average, so the average cost rises (for example the marginal cost of each extra unit between 450 and 500 is 4.8 and this increase in output has the effect of raising the cost per unit from 1.8 to 2.1). From http://tutor2u.net/economics/revision-notes/a2-micro-supply-shortrun-costs.html.
19. Real Exchange rate:
The real exchange rate is the nominal exchange rate multiplied by (P*/P), where P* is the foreign price level and P is the domestic price level.
Example: If the price of goods in Japan increases by 5% but the € appreciates 5% against the ¥, then the price of goods remains the same for someone in the Euro zone.
20. Trade Surplus:
A positive balance of trade is known as a trade surplus and consists of exporting more than is imported.
Example: Ireland’s trade surplus in 2006 comprised:
Data source: http://www.cso.ie/statistics/botmaintrpartners.htm
Lecture 2 Exercise 3
Y* = G/q
if q falls, then Y* rises
Or subsequently
If q rises , then Y*falls
This will happen because when the Personal Income Tax Rate (q) falls then Taxes (T=qY) fall. This will cause a rise in Disposable Income of Households (YD=Y-T), which will result in a rise in Consumption (C=a1YD+a2H-1) and vice versa. This will result in a rise in National Income (Y=G+C).
if q falls, then Y* rises
Or subsequently
If q rises , then Y*falls
This will happen because when the Personal Income Tax Rate (q) falls then Taxes (T=qY) fall. This will cause a rise in Disposable Income of Households (YD=Y-T), which will result in a rise in Consumption (C=a1YD+a2H-1) and vice versa. This will result in a rise in National Income (Y=G+C).
Amendment (05/05/08) - The effect of lowering the tax rate from 20% to 10% can be seen from the following workings, where the "n" column represents the steady state:
1 comment:
Competent summary, some nice examples.
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