Macroeconomics 2HH3Chapter 5The Closed-EconomyOne-PeriodMacroeconomic Model

SOURCES OF SOCIAL INEFFICIENCIES

HOW TO USE THE MODEL

INTERPRETATION OF THE MODEL'SPREDICTIONS

closed economy

an economy that does not trade withthe rest of the world

open economy

an economy that trades with the rest of the world

public goods

goods that are difficult or impossible for the privatesector to provide, for example, national defence

exogenous variable

a variable determined outside the model

endogenous variable

a variable that the model determines

government budget constraints

an equation describing the sources and uses ofgovernment revenues

fiscal policy

the government choices over government expenditures,taxes, tranfers, and government borrowing

competitive equilibrium

a state of the economy in which prices and quantitiesare such that the behaviour of price-taking consumersand firms are consistent

market clearing

when supplyequals demand in a particularmarket or markets

production possibilities fortier (PPF)

the boundry of a set that describes what consumptionbundles can be technologically exchanged for another

Pareto-optimality

A state of the economy that cannot be improved onby making on consumer better off without makinganother worse off

first fundamental theorem of welfare economics

results stating that, under certain conditions, a competitive equilibriumis Pareto-Optimal

second fundamental theorem of welfare economics

result stating that, under certain conditions, a Paretooptimum is a competive equilibrium

externality

the effect an action taken by an economic agent has onanother economic agent or agents, where the agent performingthe action does not take into account this effect on others

distortion tax

a tax, such as an income tax, that creates a difference betweenthe effective prices faced by buyers and sellers of some good

crowding out

the displacement of private expenditures by governmentpurchases

long run

typically describes macroeconomic effects that occur beyond a years time

short run

typically describes macroeconomic effect that occur within a year'stime

real business cycle theory

a theory postulating that the primary cause of aggregate fluctuationsis fluctions in total factor productivity

intertemporal substitution of labour

the substitution of labour over time by a worker in responseto movements in real wages