Economics Study Guide Macro

Economics Study Guide Macro - What are the true costs of...

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What are the true costs of inflation? Inflation does not erode real wages. Inflation does not favor borrowers at expense of lenders if inflation is anticipated. i=r+Einflation (Fisher equation unexpectedly high, inflation helps borrowers, if inflation lower than expected, lenders win) Other costs of inflation: - inflation tax – all inflation, whether anticipated or not, reduces real value of CASH holdings o if I keep $50,000 in mattress, and inflation is 10% in 2009, then the real value of that cash falls by 10% o can avoid inflation tax by keeping wealth in interest-bearing assets (bank accounts, CD’s, money market mutual fund, etc.) Inflation will be reflected in i paid by such accounts, so wealth protected from anticipated inflation. o How important is it? Cash is minor % of wealth in US so inflation tax not that important More important where cash was key in people’s portfolios: poor people in US, less developed counties today, earlier periods of history, underground economy (mob). - Menu costs – firms pay to change nominal prices, higher when inflation is high (change catalog and aisle prices) - Shoe leather costs – during high inflation people spend more time shopping for low prices, go to banks more often. o Hyperinflation = > 10% per month. In Europe during/following WWI+WWII. Latin America 1980s-19990s What is the Classical Model of the economy? Popular before 1930a 1. Society produces on its PPF each period (never inside) a. PPF shows max. amount of Y economy can produce for given leisure (aggregate economy’s resource + technological constraints) 2. Resources in economy are always FULLY EMPLOYED each period: a. Actual Y=potential b. Actual UR=natural rate c. Does not assume everyone works long hours 365 days a year d. Assumes we produce as much Y as technologically possible, given desired leisure time 3. Business cycles can be caused by supply and preference shocks a. Supply shocks (shifts in PPF) i. Favorable example: inventions, new resource energy, internet developed in 1990s making economy more productive, can produce more Y for given level of leisure. PPF shifts up ii. Unfavorable: droughts, natural disasters, oil embargoes, 1973 OPEC limits oil production, recession b. Preference shocks (movements along PPF)
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i. WWII: surge of patriotism, people willing to work harder in order to increase Y. ii. Can be due to changes in Y 4. No role for government intervention to combat business cycles: fluctuations in Y over cycle represent society’s optimal response to supply shocks, government cannot improve matters by trying to stabilize economy. 5. Problems with classical view: a. Can’t explain increases in involuntary unemployment during recessions.
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