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study guide - exam 1

# study guide - exam 1 - Topic 1 Goods market National income...

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Topic 1 Goods market National income determination : how income is determined in an economy and what affects it o Demand = C + I + G + X –IM o If drop rest of world, Z = C + I + G C: depends on Y d –> C = c 0 + c 1 Y D C 0 is autonomous consumption C 1 is MPC o MPC = slope of demand curve o APC: c/Y D = c 0 /Y D + c 1 APC decreases when Y D increases MPC < APC o S = Y D – C MPS: dS/dY D = 1 – c 1 APS: s/Y D = -c 0 /Y D + (1-c 1 ) APS increases when Y D increases MPS > APS Y D = Y – T G and T are exogenous to this model (not functions of things such as income, unlike consumption) Equilibrium condition: Y = c 0 + c 1 (Y-T) + I + G To solve for Y = (c 0 – c 1 T + I + G)/(1-c 1 ) Top part (c 0 – c 1 T + I + G) is autonomous spending o Part on graph between 45 degree line and demand

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Bottom part [1/(1-c 1 )] is the multiplier : original amount is multiplied into a larger amount Important assumptions: no money, no inflation, no time, no production or labor market, no uncertainty, no optimization by household/firm, no growth Private Saving : S = Y D – C = Y – T – C o Public Saving : what government earns and spends; T – G When positive, gov’t in budget surplus. When negative, gov’t in budget deficit o S = I + G –T -> investment = private saving + public saving o Equilibrium equation can now be written: Y – T – C = I + G – T S up -> Y down (paradox of saving)
Topic 2 Financial Assets Assumption: only 2 assets, money and bonds Goal: find out how much of each they hold Assumption: money does not pay interest, while bond pays interest rate of i Demand for money depends on o Amount of transactions: need to hold more money when need to buy more goods o I : when interest is higher, bonds are more attractive, and you hold less money M d = \$YL( i ) o Y = Nominal income, due to transaction demand o L( i ) < 0, due to asset demand Gov’t fixes money at M S G increases money supply -> M S shifts right -> I goes down and Money goes up o Central bank doesn’t directly change the money supply; it does it through i o Central Bank changes money supply through open market operations Wants to increase M -> buys bonds

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Wants to decrease M -> sells bond (money now tied up in bonds) Don’t need to worry about bond market because when money market is in equilibrium, bond market is also in equilibrium (Walras Law) Price of a bond = price it will pay a year from now/(1+
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study guide - exam 1 - Topic 1 Goods market National income...

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