1. Final Exam Review Macroeconomics Econ EB222 Fall 2012 Inst. Shan A. Garib Mohawk College

2. Final Exam Macroeconomics Date: Friday, December 14 th 2012 Time: 11:00am – 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 Propensity to Consume (MPC) MPC = in Consumption in Income CHANGE CHANGE

6. 45 $1000 $6000 ?

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

8. At a Y,GDP 0 = $10,000bn, consumption (C 0 ) is $8,600 bn. The MPC = 0.25. At a Y, GDP 1 of $9,000bn, how much would be saved? (Assume there is no taxes in the economy) Since there are no taxes, disposable income (DI) = (Y,GDP). ChngC = MPC x ChngDI ChngDI = $10,000bn - $9,000bn = $1,000bn ChngC = 0.25 x -$1,000bn = -$250bn. Since C 0 was $8,600bn, the ChngC 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 = $550bn.

9. Remember!! ChngC = MPC x ChngDI. If MPC = 0.50 ChngDI +$50,000 ChngC = 0.50 x $50,000bn = $25,000 If C 0 $25,000, with ChngC = $25,000 C 1 = $25,000 + $25,000 = $50,000.

10. 10 Fiscal Policy and the Public Debt Chapter 10&11 Instructor Shan A. Garib, Fall 2012

11. 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 b P2P2 LRAS Price Level P1P1 Y2Y2 AD 1 AD 2 Y1Y1 c SRAS b P2P2 LRAS Price Level P1P1 AD 1 AD 2 c SRAS 1 Y1Y1 d SRAS 2 Higher P, and wages, costs SRAS shift left

12. 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

13. 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

14. 14 Money and the Banking System Chapter 12 Instructor Shan A. Garib, Fall 2012

15. Defining Money (cont'd) The transactions approach to measuring money: M1 Currency Checkable (transaction) deposits Traveler’s checks not issued by banks

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

17. 17 Money Creation and Deposit Insurance Chapter 13 Instructor Shan A. Garib, Fall 2012

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

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

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

21. 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)

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

23. 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

24. 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

25. The Bank of Canada purchases $10,000 of Canadian government bonds on the open market directly from Scotia Bank. If the required reserve ratio (m) is 25%, then the maximum potential change in the money supply as a result of the open market operation will be?: All $10,000 of these new reserves are excess reserves, because: Required Reserves = M x Demand Deposits and there has been no change in demand deposits so,: Required Reserves = 25% x 0 = 0 Therefore, Excess reserves = Reserves of $10,000 - Required Reserves of 0 = $10,000 Resultant change in the money supply: = 1/m x initial change in excess reserves. = (1/.25) x $10,000 = 4 x $10,000 = $40,000

26. BMO has $160 million of reserves. The M 20%. The Bank of Canada then lowers M to 16%. How much can RBC 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.

27. 1997's money GDP was $8,320 billion. 1997's price level index was 102.0. In 1997 to 2001, what is the real GDP 1997's real GDP: Real GDP = (Money GDP/Price Level Index) x 100 Real GDP for 1997 = ($8,320 billion/102.0) x 100 = $81.57 billion x 100 = $8,157 billion.