Final Exam Review Macroeconomics Econ EB222 WIN 2013 Inst. Shan A. Garib Mohawk College

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

Consumption, Investment and the Multiplier: Chapter 9

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)

Marginal Propensity to Consume (MPC) MPC = in Consumption in Income CHANGE CHANGE

45 $1000 $6000 ?

C 5700 $6000 Saving = $300 $2700 $3000 Dissaving = $300 $2700 Saving = - $300

Y,GDP 0 = $10,000bn (C 0 ) is $8,600 bn. MPC = 0.25 Note: In mathematics, Dx = “Change in” At a Y, GDP 1 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 C 0 was $8,600bn, the DxC of -$250bn will bring consumption down to C 1 = $8,350bn (= $8,600bn - $250bn). If, S = DI – C 1 At a national income of $9,000bn (S) = $9,000bn of DI - $8,350bn of C = $650bn.

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

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) b P2P2 LRAS Price Level P1P1 Y2Y2 AD 1 AD 2 Y1Y1 c SRAS P2P2 LRAS Price Level P1P1 AD 1 AD 2 c SRAS 1 Y1Y1 d SRAS 2 Higher P, and wages, costs SRAS shift left Let’s say, there is a war and the government buys planes and guns, “G” goes up b

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 c P2P2 LRAS Price Level P1P1 AD 2 AD 1 b SRAS c P2P2 LRAS Price Level P1P1 AD 2 AD 1 d SRAS 2 Y 2 Y 1 b SRAS 1 Lower P, and wages, costs SRAS shift right Let’s say, there is a war and the half the population dies, “C” goes down

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 Surplus is 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

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

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

Reserves – deposits held by BOC for chartered banks like BMO, plus their vault cash Reserves

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

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

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)

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

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

The Money Multiplier (cont'd) Example – Fed buys $100,000 of government securities – Reserve ratio = 10% Potential change in the money supply = $100,000 = $1,000,000 x 1.10

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

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.