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

2. Final Exam Macroeconomics Date: Monday, April 15 th 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 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. 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. 9 Fiscal Policy and the Public 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) 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

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 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

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 Surplus is when Revenues > Spending 0 > Revenue – Spending Budget Deficit is when Revenues < Spending 0 < Revenue – Spending

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

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

18. 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. 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

23. 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

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.