Final Exam Review Macroeconomics

1. Final Exam ReviewMacroeconomics Econ EB222 WIN 2013 Inst. Shan A . Garib Mohawk College

2. Final Exam Macroeconomics Date: Monday, April 15th 2013 Time: 12:30pm – 2:00pm In-Class Review ALL Quizzes given in class

3. Consumption, Investment and the Multiplier: Chapter 9

4. Consumption (Continued) • The consumption functions states • As income rises, consumption (C) rises, but not as quickly Income = Consuption + Saving + taxes Y = C + S + t and, Disposible Income = Consuption + Saving Yd = C + S or, Yd = Y - t Therefore, consumption varies with disposable income (DI)

5. Marginal Propensityto Consume (MPC) CHANGE in Consumption MPC = CHANGE in Income

6. $6000 ? Consumption & Saving $1000 45 $1000 $6000 Disposable Income ($)

7. Saving = $300 5700 $2700 $2700 $6000 C Consumption & Saving $3000 Saving = - $300 Dissaving = $300 $6000 Disposable Income ($)

8. Y,GDP0 = $10,000bn (C0) is $8,600 bn. MPC = 0.25 Note: In mathematics, Dx = “Change in” At a Y, GDP1 of $9,000bn, how much would be saved? (Assume there is no taxes in the economy)   DxC = MPC x  DxDI DxDI = $9,000bn - $10,000bn = -$1,000bn DxC = 0.25 x  -$1,000bn = -$250bn. Since C0 was $8,600bn, the DxC of -$250bn will bring consumption down to C1 = $8,350bn (= $8,600bn - $250bn). If, S = DI – C1 At a national income of $9,000bn (S) = $9,000bn of DI - $8,350bn  of C = $650bn.

9. Fiscal Policy and thePublic Debt Chapter 10&11 Instructor Shan A. Garib, WIN 2013

10. Expansionary fiscal policy • If budget is initially balanced, moves it towards a budget deficit during recession • Increased government spending (G) and/or lower taxes • Aim to stimulate economic activity and to move the economy out of a recession • AD = C + I + G + (X-N) Let’s say, there is a war and the government buys planes and guns, “G” goes up Higher P, and wages, costs SRAS shift left LRAS LRAS SRAS2 SRAS SRAS1 c d c P2 P2 Price Level Price Level P1 P1 b b AD2 AD2 AD1 AD1 Y1 Y2 Y1

11. Contractionary fiscal policy • If budget is initially balanced, moves it towards a budget surplus during an inflationary period • Decreased government spending and/or higher taxes • Aim to control demand and reduce demand-pull inflation Let’s say, there is a war and the half the population dies, “C” goes down Lower P, and wages, costs SRAS shift right LRAS LRAS SRAS1 SRAS SRAS2 b b P2 P2 Price Level Price Level P1 c P1 c AD1 AD1 d AD2 AD2 Y2 Y1

12. Government Budgets and Finances • Government’s budget balance is amount of revenue it recieves minus its spending Balanced budget is when: Revenues = Spending 0 = Revenue – Spending Budget Surplusis when Revenues > Spending 0 > Revenue – Spending Budget Deficit is when Revenues < Spending 0 < Revenue – Spending

13. Money and the Banking System Chapter 12 Instructor Shan A. Garib, WIN 2013

14. Defining Money (cont'd) • The transactions approach to measuring money: M1 􀂃 Currency 􀂃 Deposits you can write a check for 􀂃 Traveler’s checks

15. Defining Money (cont'd) • The liquidity approach: M2 is equal to M1 plus 1. Savings & time deposits 2. Balances in retail money market mutual funds 3. MMDAs

16. Money Creation and Deposit Insurance Chapter 13 Instructor Shan A. Garib, WIN 2013

17. Reserves • Reserves • deposits held by BOC for chartered banks like BMO, plus their vault cash

18. Reserves • Legal Reserves • Anything that the law permits banks to claim as reserves—for example, deposits held at BofC and vault cash

19. Reserves • Required Reserves • The value of reserves that a depository institution must hold in the form of vault cash or deposits with the BofC

20. Reserves • Required Reserve Ratio • 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)

21. Reserves • Excess Reserves • The difference between legal reserves and required reserves Excess reserves = Legal reserves – Required reserves

22. 1 Potential money multiplier = Required reserve ratio Actual change in the money supply Actual money multiplier Change in total reserves =  The Money Multiplier (cont'd)

23. 1 .10 Potential change in the money supply = $1,000,000 $100,000 = x The Money Multiplier (cont'd) • Example • Fed buys $100,000 of government securities • Reserve ratio = 10%

24. Scotia Bank has NO excess reserves Bank of Canada purchases $10,000 of bonds with a check from a man named Mr. Harper Mr. Harper deposits this check into his account in Scotia Bank NOTE: 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 25% The 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 = 0.25 * $10,000 Required Reserves = $2500 Therefore, Excess reserves = Reserves - Required Reserves Excess reserves = $10,000 - $2500 = $7500 Resultant change in the money supply the banks can create: = 1/m x Dx(Excess Reserves) = (1/.25) x $7500 = 4 x $7,500 = $30,000 Then, the TOTAL change in money supply is: = initial demand deposit + Dx(money supply banks can create) = $10,000 + $30,000 = $40,000

25. BMO has $160 million of reserves The 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 million/.20 = 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.