Zirlott- Macro Notes Bundle
Zirlott- Macro Notes Bundle EC 111
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What Economics Is All About (Chapter 1) Scarcity: the limited nature of society’s resources Economics: the study of how society manages its scarce resources - How people decide what to buy, how much to work, save, and spend - How firms decide how much to produce, how many workers to hire - How society decides how to divide its resources between national defense, consumer goods, protecting the environment, and other needs Principle 1: People Face Tradeoffs All Decisions involve tradeoffs. Examples: - Going to a party the night before your midterm leaves less time for studying - Having more money to buy stuff requires working longer hours, which leaves less time for leisure - Protecting the environment requires resources that could otherwise be used to produce consumer goods Society faces an important tradeoff - Efficiency VS. Equality Efficiency: When society gets the most from its scarce resources Equality: When prosperity is distributed uniformly among society’s members: Every one gets an equal share Tradeoff: To achieve greater equality, could redistribute income from wealthy to poor. But this reduces incentive to work and produce, shrinks the size of the economic “pie” Principle 2: The Cost of Something Is What You Give Up to Get It Making decisions requires comparing the costs and benefits of alternative choices The Opportunity Cost (OP) of any item is whatever must be given up to obtain it o OP- cost of decision-making: EX. College. Tradeoff is working It is the relevant cost for decision making Examples: The opportunity cost of… going to college for a year is not just the tuition, books, and fees, but also the foregone wages. … Seeing a movie is not just the price of the ticket, but the value of the time you spend in the theater Principle 3: Rational People Think at the Margin Rational People - Systematically and purposefully do the best they can to achieve their objectives - Make decisions by evaluating costs and benefits of marginal changes- incremental adjustments to an existing plan - We assume people are rational. It is not always black and white o Donating to Charity o Going to Auburn o Unprotected Sex Examples: When a student considers whether to go to college for an additional year, her compares the fees and forgone wages to the extra income he could earn with the extra year of education When a manager considers whether to increase output, she compares the cost of the needed labor and material to the extra revenue Principle 4: People Respond to Incentives Incentive: something that induces a person to act, i.e. the prospect of a reward or punishment o Going to the NFL- to get millions of dollars Rational People respond to incentives Examples: When gas prices rise, consumers buy more hybrid cars and fewer gas guzzling SUVs When cigarette taxes increase, smoking fall What is the incentive for having a playoff system in college football? Money and Ratings Principle 5: Trade Can Make Everyone Better Off Rather than being self- sufficient, people can specialize in producing one good or service and exchange it for other goods Countries also benefit from trade and specialization (you do what you do best): o Get a better price abroad for goods they produce Buy at a cheaper price o Buy other goods more cheaply from abroad than could be produced at home Principle 6: Markets Are Usually A Good Way to Organize Economic Activity Market: A group of buyers and sellers (need not be in a single location) o Example: Internet, Stock Exchange “Organize Economic Activity” means determining o What goods to produce o How to produce them o How much of each to produce o Who get them Organize Economic Activity: demand, avaibilty, income, necessity, want Market Economy allocates resources through the decisions of many households and firms as they interact in markets o Circular Flow Diagram The invisible hand works through the price system o Created by Adam Smith o The interaction of buyers and sellers determines prices o Each price reflects the good’s value to buyers and the cost of producing the good o Prices guide self- interested (looking out for yourself) household’s and firms to make decisions that in many cases maximize society’s economic well being Examples: Apple - People buying more thins leads to more jobs Principle 7: Governments Can Sometimes Improve Market Outcomes Important role for government: enforce property rights (with police, courts) People are less inclined to work, produce, invest, or purchase if large risk of their property being stolen Examples: Walking Dead, and The Purge- both have no governments… Survival of the Fittest Market Failure: When the market fails to allocate society’s resources efficiently Causes: o Externalities: When the production or consumption of a good affects bystanders (pollution from cars) o Market Power: a single buyer or seller has substantial influence on market price (monopolies) They want competition- because its how we get lower prices In such cases, public policy may promote efficiency o EPA Laws, Laws against monopolies Example: Rite merging with Walgreens Government may alter market outcome to promote equity If the market’s distribution of economic well- being is not desirable, tax welfare polices can change how the economic “Pie” is divided Principle 8: A country’s standard of living depends on its ability to produce goods and services. The most important determinant of living standards: productivity, the amount of goods and services produced per unit of labor Productivity depends on the equipment, skills, and technology available to workers Other Factors (labor unions, competition from abroad) have far less impact on living standards GDP- How much it can produce o All have equipment, skill, technology, and workers o Example: Internet, railroads, plants, school systems Africa- Extremely rich in natural resources/ raw materials but they don’t have equipment/ resources Principle 9: Prices rise when the government prints too much money Inflation: increases in the general level of prices o Rising prices In the long run, inflation is almost always caused by excessive growth in the quantity of money, which causes the value of money to fall The faster the government creates money, the greater the inflation rate Principle 10: Society faces a short- run tradeoff between inflation and unemployment (Philips Curve) IN the short run (1-2 years), many economic policies push inflation and unemployment in opposite directions Other factors can make this tradeoff more or less favorable, but the tradeoff is always present o Higher price: lower unployment Macro Chapter 2 Notes Assumptions and Models - Assumptions simplify the complex world, and make it easier to understand. - Model: a highly simplified representation of a more complicated reality o Economists use these models to study economic issues o Used to make something easier to understand and comprehend The Circular Flow Diagram - The Circular Flow Diagram: a visual model of the economy o Shows how dollars flow through markets among households and firms - Two types of “actors o Households- which are the consumers o Firms- which are the businesses - Two markets: o The market for goods and services o The market for “factors of production” - Households o Own the factors of production. They sell/ rent them to firms for income o Buy and consume goods and services - Firms o Buy/ hire factors of production, and use them to produce goods and services o The firms sell the goods and services to consumers Factors of Production - Factors of Production: o The resources the economy uses to produce goods and services, including (inputs) o Put into three categories 1. Labor- the people 2. Land- the raw materials or natural resources Example: If you are producing coke: the water, caffeine, corn syrup, etc. are all considered land 3. Capital- the buildings and machines used in production 4. Entrepreneurship- the ideas (Apple the company) The Productions Possibilities Frontier (PPF) - The PPF: a graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology o Maximum we can get from what is given o Always has tradeoffs - The opportunity cost of an item is what must be given up to obtain that item - Moving along the PPF involves shifting resources (labor) from the production of one good to the other - Society faces a tradeoff: Getting more of one good requires sacrificing some of the other. - The Slope of the PPF tells you the opportunity cost of one good in terms of the other The Shape of the PPF - The PPF could be a straight line, or bowed- shaped (bow outward) - Depends on what happens to the opportunity cost as the economy shifts its resources from one industry to another o If the Opportunity cost remains constant= a straight line, essentially the same resources are equally useful for producing in either industry 1. Example: Coke and Pepsi- they have tradeoffs o If the opportunity cost of a good rises as the economy produces more of the good, the PPF is bow- shaped (Rounded). Essentially, the resources are specialized and not easily adaptable for producing in either industry. 1. This is the majority of all PPF’s Slope – if a line equals rise over run With additional resources or an improvement in technology, the economy can produce more of (i.e computers, or wheat, or any combination in between). Why the PPF might be Bow- Shaped - As the economy shifts resources from beer to mountain bikes: o The PPF becomes steeper o Opportunity cost of mountain bikes increases o As you move down the curve the more money - The PPF is bowed- shaped when different workers have different skills, different opportunity costs of producing one good in terks of the other. - The PPF would also be bowed- shaped when there is some other resource, or mix of resources with varying opportunity costs o Different type of land suited for different uses The PPF: Important Notes - The PPF shows all combinations of two goods that an economy can possibly produce, given its resources and technology - The PPF illustrates the concepts of tradeoff and opportunity cost, efficiency and inefficiency, unemployment, and economic growth - A bow- shaped PPF illustrated the concept of increasing opportunity cost. A straight line PPF illustrates constant opportunity costs Microeconomics- is the study of how households and firms make decisions and how they interact in markets Macroeconomics- is the study of economy- wide phenomena, including inflation, unemployment and economic growth These two branches of economics are closely intertwined, yet distinct- they address different questions The Economist as Policy Advisor - As scientists, economists make o Positive Statements- fact or description of a relationship that is true 1. It attempts to describe the world as it is - As policy advisors, economists make o Normative statement 1. Opinion or valued judgment 2. They attempt to prescribe how the world should be Examples: Prices rises when the government increases the quantity. Positive The Government should print less money. Normative A tax cut is needed to stimulate the economy. Normative An increase in the price of burritos will cause an increase in consumer demand for taco. Positive Points PPF: - Possible - Efficient: all resources are fully utilized Points Under: - Possible - Not efficient: some resources underutilized (workers unemployed) Points Above - Currently unattainable Macroeconomics Chapter 4 Notes Markets and Competition Market: is a group of buyers and sellers of a particular product Competitive Market: has many buyers and sellers, each has a negligible effect on price - Can’t argue over price and can’t negotiate Market Types include: - Perfect competition - Monopoly - Monopolistic competition Demand Quantity Demanded (QD) - is the amount of the good that buyers are willing and able to purchase at a specific price - Specific amount at a specific price Demand curve- is a set of various quantities demanded at corresponding prices. It is also the curve itself Law of Demand- the claim that the quantity demanded of good falls when the price of the good rises - Inverse The Demand Schedule This is a table that shows the relationship between the price of a good and the quantity demanded Price of Lattes Quantity of Lattes Demanded $0.00 16 $1.00 14 $2.00 12 $3.00 10 Then you plot the points on a graph and it will make a demand curve Market Demand VS. Individual Demand - The quantity demanded in the market is the sum of the quantities demanded by all buyers at each price Demand Curve Shifters - It shows how price affects quantity demanded. - A change in the price of the good changes quantity demanded and results in a movement along the demand curve - “other things” are non- price determinants of demand which determines a buyers demand for a good Demand Curve Shifters: Number of Buyers - Increase in the number of buyers increase quantity demanded at each price shifts the demand curve to the right - Right = increase in demand - Left = decrease in demand Demand Curve Shifter: Income - Demand for a normal good is positively related to income o Increase in income cause increase in quantity demanded at each price - Demand for an inferior good is negatively related to income Demand Curve Shifters: Prices of Related Goods - Two goods are substitutes if an increase in the price of one cause an increase in demand of the other - If two goods are complements if an increase in the price of one causes a fall in demand for the other Demand Curve Shifters: Tastes - Anything that causes a shift in the taste toward a good will increase demand for that good and shift its demand curve to the right Ex: Atkins diet became popular in the 90s caused an increase in demand for eggs. Demand Curve Shifters: Expectations - This affects consumer buying decisions Supply Quantity Supplied – the amount that sellers are willing and able to sell at a specific price Supply curve- is a set of various quantities supplied at corresponding prices Law of Supply- the claim that the quantity supplied of a good rises when the price of the good rises The supply schedule - Table that shows relationship between the price of good and the quantity supplied - Table is the same as demand schedule Market SUPPLY - Quantity supplied in the market is the sum of the quantities by all sellers at each price Supply Curve Shifters Input Prices - Wages, prices of raw materials - Fall in input prices makes production more profitable at each output price Technology - Determines how much inputs are required to produce a unit of output Number of Seller - Increase in number of sellers increases the quantity supplied at each price Expectations - Ex: events in Middle East lead to expectations of higher oil prices Equilibrium: the price that equates quantity supplied with quantity demanded - QD=QS Equilibrium Quantity- the quantity supplied and quantity demanded at the equilibrium price Surplus: above the equilibrium - When quantity supplied is greater than quantity demanded Shortage- below equilibrium - When quantity demanded is greater than quantity supplied Three Steps to Analyzing Changes in Equilibrium 1. Decide whether event shifts Supply ir demand or both 2. Decide in which direction curve shifts 3. Use supply demand diagram to see how the shift changes equilibrium P and Q Terms of Shift Vs. Movement along Curve - Change in supply- shift in the S curve o Occurs when a non price determinant of supply changes - Change in the quantity supplied – movement along a fixed S curve o Occurs when price changes - Change in demand – a shift in the D curve o Occurs when a non price determinant of demand changes - Change in the quantity demanded- movement along a fixed D curve o Occurs when price changes Chapter 5 Notes: Macro Elasticity – measures how much of a variable responds to different changes in another variable - One type of elasticity measures how much demand for your websites will fall if you raise your praise - Elasticity is a numerical measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants Price Elasticity of Demand - Percentage change in Quantity Demanded divided by percentage change in price - Measures how much quantity demanded responds to a change in price - Measures the price sensitivity of buyers demand - Elasticity is pure number Calculating Percentage Changes - ((end value- start value)/ (start value)) - Midpoint method is the average - Midpoint is the number halfway between the start and the end values, the average of those value - Doesn’t matter which number is the “start” and the “end” you get the same answer Example: Price= 70 Quantity Demanded= 5000 Price= 90 Quantity Demanded= 3000 What is the Percent change in price? (90- 70)/ 80= .25 Then multiple the .25 by 100 which gives you 25% What is the percent change in demand? (5000-3000)/ 4000= .50 Times the .50 by 100 which gives you 50% Variety of Demand Curves - The slope is the ratio of two changes and elasticity is a ratio of two percent change Rule of thumb: the flatter the curve, the bigger the elasticity The steeper the curve the smaller the elasticity Five different demand curves 1. Elastic Demand: relatively flat curve a. Consumers price sensitivity i. Relatively high ii. Elasticity is greater than 1 2. Inelastic Demand a. Demand curve is relatively steep b. Consumers price sensitivity: relatively low c. Elasticity is less than 1 3. Unit Elastic Demand a. Demand curve is intermediate slope b. Consumers price sensitivity is intermediate c. Elasticity is 1 4. Perfectly Inelastic Demand a. Demand curve is perfectly vertical b. Consumers price sensitivity: there is none c. Elasticity is zero 5. Perfectly Elastic Demand a. Demand curve is horizontal b. Consumers price sensitivity is extreme c. Elasticity: infinity What determines price elasticity? - Looking at a series of examples that are comparing two common goods 3 - Example: 1. Suppose the prices of both goods rise by 20% 2. The good for which quantity demanded falls the most (in percent) has the highest price elasticity of demand Example: Breakfast cereal VS. Sunscreen - Breakfast cereal has close substitutes so consumers 1. Waffles, oatmeal, and grits are all different substitutes for a breakfast meal. So the consumers can easily switch if the price rises - Sunscreen: has no substitutes, so consumers would probably not buy much less if its prices rise. - Price elasticity is higher when close substitutes are available - Price elasticity is higher for luxuries than for necessities - Price elasticity is higher for narrowly defined goods than broadly defined goods - Price elasticity is higher in the long run than in the short run Determinants of Price Elasticity: - The extent to which close substitutes are available - Whether the good is a necessity or a luxury - How broadly or narrowly the good is defined - The time horizon- elasticity is higher in the long run than the short run Luxury is something you want Necessity is something that you need to survive Price Elasticity and Revenue - Revenue = price times quantity - A price increase has two effects on the revenue 1. Higher price means more revenue on each unit you sell 2. But you sell fewer units (lower quantity) due to law of demand 3. If demand is elastic, then price elasticity of demand is greater than 1 4. If demand is inelastic then the price elasticity is less than one 5. When demand is elastic a price increase causes revenue to fall 6. When demand is inelastic a price increase causes revenue to rise Price elasticity of supply - Measures how much quantity supply responds to a change in price - Measures sellers price sensitivity - Also uses midpoint method - Percent change in quantity supplies/ percent change in price Variety of supply curves - Slope of the supply curve is closely related to price elasticity of supply - Flatter the curve the bigger the elasticity - Steeper the curve, the smaller the elasticity Five classifications Inelastic - Supply curve- relatively steep slope - Sellers price sensitivity is low - Elasticity is less than one Unit Elastic - Supply curve- has intermediate slope - Intermediate price sensitivity - Elasticity is equal to one Elastic - Supply curve is relatively flat - Price sensitivity is high - Elasticity is greater than one Perfectly Elastic - Supply curve is horizontal - Price sensitivity is extreme - Elasticity is infinity Perfectly inelastic - Supply curve is vertical - Price sensitivity is none - Elasticity is zero Determinants of Supply Elasticity - More easily sellers can change the quantity they produce, the greater the price elasticity of supply - For many goods, price elasticity of supply is greater in the long run than in the short run, because new firms can build new factories, or new firms may be able to enter the market. Other Elasticities - Income elasticity of demand: measures how the response of quantity demanded to a change in consumer income 1. For normal goods income elasticity is greater than zero 2. For inferior goods, income elasticity is less than zero - Cross price elasticity of demand 1. Measures demand for one good to changes in price of another good 2. Percent change in quantity demanded for good 1 divided by percent change in price of good 2 3. For substitutes cross price elasticity is greater than zero 4. Complements are less than zero Macroeconomics Chapter 10 Notes Income and Expenditure - Gross Domestic Product (GDP) o Measures the total income of everyone in the economy o Measure the total expenditure on the economy’s output of goods and services - For the economy as a whole income is equal to expenditure o For every dollar a buyer spends is a dollar of income for the seller The Circular Flow Diagram - Factors of Production o Are inputs like labor, land, capital, and natural resources - Factor Payments o Payments to the factors of production like wages and rent What this Diagram Omits - The government o Collects taxes, buy goods and services - The financial system o Matches savers supply of funds with borrowers demand for loans - The foreign sector o Trades goods and services, financial assets, and currencies with the country’s residents Gross Domestic Product…… - Is the market value of all final goods and services produced within a country in a given period of time o Goods are valued at their market prices (Market Value) All goods measured in the same units such as dollars in the US and pounds in England Things that don’t have a market value are excluded like homework, housework, and cooking which you all do by yourself - Is the market value of all final goods and services produced within a country in a given period of time o Final Goods- intended for the end user Only includes price of item as a whole The ford trucks costs $26,000 not $2,000 for each individual part o Intermediate Goods- used as components or ingredients in the production of other goods - Is the market value of all final goods and services produced within a country in a given period of time o Tangible goods DVD’s, mountain bikes, beer o Intangible goods Dry cleaning, concerts, cellphone service - Is the market value of all final goods and services produced within a country in a given period of time o GDP includes currently produced goods, not goods produced in the past Only current goods Used on eBay, used textbook and used car are not included - Is the market value of all final goods and service produced within a country in a given period of time o GDP measures the value of production that occurs within a country’s borders whether done by its own citizens or by foreigners located there Doesn’t matter who the company is owned but where it is produced does American companies produced items in different countries doesn’t count in US GDP - Is the market value of all final goods and services produced within a country in a given period of time o Usually a year or a quarter (3 months) Components of GDP - GDP is total spending - Four Components o Consumption © o Investment (I) o Government Purchases (G) o Net Exports (NX) - Y= C + I + G+ NX Consumption - Total spending by households on goods and services o Spent by yourself - Housing Costs o For Renters Consumption includes rent payments and is included in GDP o For Homeowners – lives in house Consumption includes the imputed rental value of the house, but not the purchase price or mortgage payments Investment - Total spending on goods that will be used in the future to produce goods - Includes spending on o Capital equipment (machines, tools, technology) o Structures (factories, office buildings) o Inventories (goods produced but not yet sold) o Houses (called residential fixed investment, has to have never lived in house, so brand new) - Investment does not mean the purchase of financial assets like stocks and bonds Government Purchases - is all the spending on the goods and services purchased by government at the federal, state, and local events. - They exclude transfer payments such as Social Security or unemployment insurance benefits - Not purchases of goods and services Net Exports - NX= exports – imports - Exports represent foreign spending on the economy’s goods and services o Foreign people buying our goods - Imports are the portions of consumption, investment, and government purchases that are spent on goods and services produced abroad o US buying goods from other countries Real VS. Nominal GDP - Inflation can distort economic variables like GDP, so they have two versions of GDP o One is corrected for inflation, the other is not - Nominal GDP o Values output using current prices o Is not corrected for inflation o Current output and current prices - Real GDP o Values output using the prices of a base year o Corrected for inflation o Current input and base year price is fixed GDP Deflator - Measure of overall level of prices - GDP= 100 x (nominal GDP/ real GDP) Why do we care about GDP? - Having a larger GDP enables a country to afford better schools, a cleaner environment, health care - Many indicators of the quality of life are positively correlated with GDP o Life expectancy o Literacy o Internet usage and technology Chapter 10 SUMMARY Gross Domestic Product measures a country’s total income and expenditure The Four spending components of GDP include: Consumption, Investment, Government Purchases, and Net Exports Nominal GDP is measured using current prices. Real GDP is measured using the prices of a constant base year and is corrected for inflation GDP is the main indicator of a country’s economic well- being, even though it is not perfect Macro Chapter 11 Notes The Consumer Price Index - Known as CPI - Measures the typical consumer’s cost of living - The basis of cost of living adjustments (COLAs) in many contracts and in Social Security How CPI is calculated (have to go in order) 1) Fix the “basket”- any store a. The Bureau of Labor Statistics (BLS) surveys consumers to determine what’s in the typical consumer’s shopping basket 2) Find the prices a. The BLS collects data on the prices of all the goods in the basket 3) Compute the basket’s cost a. Use the prices to compute the total cost of the basket 4) Choose a base year (base year is given) and compute the index a. CPI in any year equals i. 100 x (Cost of basket in current year/ cost of basket in base year) 5) Compute the inflation rate a. The percentage change in the CPI from the preceding period i. Inflation Rate= ((CPI this year- CPI last year)/ (CPI last year)) x 100% b. (New-old)/ old Problems with the CPI 1) Substitution Bias a. Over time, some prices rise faster than others b. Consumers, substitute toward goods that become relatively cheaper c. The CPI misses this substitution because it uses a fixed basket of goods d. CPI overstates increases in the cost of living i. Everyday people substitute 2) Introduction of New Goods a. The introduction of new goods increases variety, allows consumers to find products that more closely meet their needs i. Stretch your dollar around more stuff b. In effect, dollar becomes more valuable c. The CPI misses this effect because it uses a fixed basket of goods d. Thus, the CPI overstates increases in the cost of living e. CPI is generally updated every 5 years 3) Unmeasured Quality Change a. Improvements in the quality of goods in the basket increase the value of each dollar b. The BLS tries to account for quality changes but probably misses some, as quality is hard to measure c. Overstates increases in the cost of living - Each of these problems causes the CPI to overstate cost of living increases - BLS has made technical adjustments (but can’t fix them all) but the CPI probably still overstates inflation by about .5% per year o Could be another billion to welfare etc. - This is important because Social Security payments and many contract have COLAs tied to the CPI Contrasting the CPI (consumers only) and GDP Deflator - Imported Consumer goods o Included in CPI o Excluded from GDP Deflator - Capital Goods (investment goods) o Excluded from CPI o Included in GDP Deflator (produced domestically) - The Basket (doesn’t change, all currently produced stuff) o CPI uses fixed basket (updated every 5 years) o GDP Deflator uses basket of currently produced goods and services (updated automatically) - They both measure inflation but in different ways Examples: A) Starbucks raises the price of Frappuccino’s a. Both affect because CPI and GDP both rise B) Caterpillar raises the price of the industrial tractors it manufactures at its Illinois factory a. GDP increases C) Nike raises the price of the Chinese produced athletic shoes in the US a. CPI rises Correcting Variables for Inflation: Comparing the Dollar Figures from Different Times - Inflation makes it harder to compare dollar amounts from different times’ - Example: the minimum wage o $1.15 in December 1964 o $7.25 today - Did minimum wage have more purchasing power in December 1964 or today - Have to convert to todays dollars - Amount in todays dollars = Amount in year T dollars X (Price level today/ Price level in year T) - Example: o CPI in year T= 31.3, CPI= 220.3 today o Min wage was $1.15 in year T o $1.15 x (220.3/31.3)= $8.0 - Used to see how a variable has changed over time after correcting for inflation Correcting variables for Inflation: Indexation - A dollar amount is indexed (changes toward inflation) for inflation if it is automatically corrected for inflation by law or in a contract - Increase in the CPI automatically determines o The COLA in many multi- year labor contracts o The adjustments in Social security payments and federal tax brackets Real VS Nominal Interest Rates - The Nominal o Interest rate not corrected for inflation o The rate of growth in the dollar value of a deposit or debt - Real interest rate o Corrected for inflation o The rate of growth in the purchasing power of a deposit or debt - Real interest rate o Nominal interest rate- inflation rate - Real rate of growth= real interest rate Summary - The consumer price index is a measure of the cost of living. The CPI tracks the cost of the typical consumer’s basket of goods and services - The CPI is used to make the cost of living adjustments and to correct economic variables for the effects of inflation - The real interest rate is corrected for inflation and is computed by subtracting the inflation rate from the nominal interest rate. Chapter 13 Notes Macroeconomics Financial Institutions - Financial System o The group of institutions that helps match the saving of one person with the investment of another - Financial Markets o Institutions through which savers can directly provide funds to borrowers o The Bond Market A bond is a certificate of indebtness o The Stock Market Stock is a claim to partial ownership in a firm - Financial Intermediates o Institutions through which saver can indirectly provide funds to borrower o Examples: Banks Mutual funds (mortgage) Institutions that sell shares to the public and use the proceeds to buy portfolios of stocks and bonds Different Kinds of Saving - Private Saving (household) o The portion of households income that is not used for consumption or paying taxes o Y- T- C Y is income T is tax C is consumption - Public Saving o Tax revenue less than government spending o T- G T is tax revenue G is government spending National Saving - Private saving + public saving - End product (Y- C- G) o Y is income o C is consumption o G is government spending - The portion of national income that is not used for consumption or government purchases Saving and Investment - Y= C + I + G - Solve for I o I= Y – C – G - Saving is equal to investment in a closed economy o Closed economy do not trade with outside world Budget Deficit and Surpluses - Budget Surplus o An excess of tax revenue over government spending o T – G o Public saving = positive - Budget deficit o A shortfall of tax revenue from government spending o G – T o Negative public saving The Meaning of Saving and Investment - Private saving o The income remaining after households pay their taxes and pay for consumption - Examples: This is what households do with savings o Buy corporate bonds and equities o Purchase a Certificate of deposit at the bank Certificate of deposit = time deposit o Buy shares of a mutual fund o Let accumulate in saving or checking accounts - Investment o The purchase of new capital - Examples: Investment o General Motors spends 250 million to build a new factory in Flint, Michigan o You buy 5000 dollars worth of computer equipment for your business o Your parents spend 300,000 to have a new house built - In economics investment is not the purchase of stocks and bonds The market of Loanable Funds - Supply- demand model of the financial system - Helps us understand o How the financial system coordinates saving and investment o How government policies and other factors affect saving, investment, the interest rate - Assuming only one financial market o All savers deposit their saving in this market o All borrowers take out loans from this market o There is one interest rate, which is both the return and the cost of borrowing - The supply of loanable funds comes from saving o Households with extra income can loan it out and earn interest o Public saving, if positive, adds to national saving and the supply of loanable funds o If negative it reduces the national saving and the supply of loanable funds The Slope of the Supply Cure - an increase in interest rate makes saving more attractive which increases the quantity of loanable funds supplies The Market of Loanable Funds - The demand for loanable fund comes from investment o Firms borrow the moneys needed to pay for new equipment, factories and etc. o Households borrow the funds to purchase new houses The Slope of the Demand Curve - a fall in interest rate reduces the cost of borrowing, which increases quantity of loanable funds demanded - low interest rate stimulates borrowing and investing Equilibrium - Interest rate adjusts to equate supply and demand - The equilibrium quantity of loanable funds equals equilibrium investment and saving Policy 1 - Tax incentives for saving increase the supply of loanable funds - This reduces the interest rate and increases the quantity of loanable funds Policy 2 - Investment tax credit increase the demand of loanable funds - This raises the interest rate and increases the quantity of loanable funds Other Factors that will shift Savings or investments - Savings o Changes in income o Expectations - Investment o Technological Progress o Expectations Budget Deficit, Crowding Out, and Long Run Growth - Increase in budget deficit causes fall in investment - The government borrows to finance its deficit, leaving less funds available for investment – called crowding out - Investment is important for long run economic growth. Budget deficits reduce the economy’s growth rate and future standard of living. Chapter 15 Notes Labor Force Statistics - Produced by Bureau of labor Statistics (BLS), in the US Department of Labor - Based on regular survey of 60,000 households - Based on “adult population” o The adult population is 16 years or older o Minor is below - The BLS is divided into three groups o Employed – paid employees, self employed, unpaid workers in a family business, and those not working because of a temporary absence from a job (vacation, health, seasonal) o Unemployed – people looking for work People not working who have looked for work during previous 4 weeks, also includes temporary lay offs who are waiting to be recalled to a job o Not in the Labor force- everyone not looking for a job, (minor Minors, retirees, inmates, full time students, disabled people, discouraged workers (people not looking for a job), illegal immigrants - Labor force- the total number of workers, including the employed and unemployed - U-Rate (unemployment rate)- percent of the labor force that is unemployed o 100 X (number of unemployed/ labor force) - Labor force participation rate- percent of the adult population that is in the labor force o 100 X (labor force/ adult participation) Number of Employed 139.7 million Number of unemployed 13.7 million Not in labor force 85.7 million Labor Force: employed + unemployed - 139.7 + 13.7 o 153.4 million U- Rate- 100 X (unemployed/ labor force) - 100 X (13.7/153.4) o 8.9% Population- labor force + not in labor force - 153.4 + 85.7 o 239.1 Loanable Funds- 100 X (labor force/ population) - 100 X (153.4/ 239.1) o 64.2% Labor Market Statistics for Different Groups - The BLS publishes these statistics for demographic groups within the population - These data reveal widely different labor market experiences for different groups What does the U- Rate Really Measure? - U-Rate- is not a perfect indicator of joblessness or the health of the labor market o Excludes discouraged workers o Doesn’t distinguish between full and part time workers or people working part time because full time jobs available o Some people misreport their work status in the BLS survey Called a phantom worker o It does not include workers being paid “under the table” - U rate is still a very useful barometer of the labor market and economy The Duration of Unemployment - Most unemployment’s are short o 1/3 of the unemployed have been unemployed under 5 weeks, 2/3 have been unemployed under 14 weeks o 20% have been unemployed over six months Cyclical Unemployment VS the Natural Rate - Always some type of unemployment - Natural rate of unemployment o The normal of unemployment around which the actual unemployment rate fluctuates - Cyclical o The deviation of unemployment from its natural rate o Associated with business cycle Explaining the Natural Rate: - There is always some unemployment - Frictional unemployment- time it takes to find a job o Occurs when workers spend time searching for the jobs that best suit their skills and tastes o Short term for most workers - Structural unemployment – not enough jobs to go around o Occurs when there are fewer jobs than workers o Usually longer term - Both are reasons why we have a natural rate of unemployment and are both made up of three things Job Search (Frictional) - Workers have different tastes and skills and jobs have different requirements - Job Search is the process of matching workers with appropriate jobs - Sectoral Shifts o Changes in the composition of demand across industries or regions of the country - Economy is always changing and some frictional unemployment is inevitable - Both job search and sectoral shifts are frictional Public Policy and Job Search - Government employment agencies o Provide info. About job vacancies to speed up the matching of workers with jobs - Public Training programs o Provide training to help find jobs - These things are what government can do to speed up the job search programs Unemployment Insurance - UI (unemployment insurance) o Safety net o Government program that partially protects workers incomes when they become unemployed - Ui increases frictional unemployment o People respond to incentives - Increasing or extending unemployment insurance raises frictional unemployment even more - Benefits o Reduces uncertainty of income o Gives unemployed more time to search which results in better job matches and higher productivity Explaining Structural Unemployment - Not enough jobs to go around - Occurs when wage is kept above equilibrium - 3 reason 1) Minimum wage Laws a. Min. wage may exceed the equilibrium wage for the least skilled or experienced workers causing structural unemployment b. Small part of the labor force c. Increasing the min wage raises structural unemployment by increasing the quantity supplied labor and decreasing the quantity demanded labor 2) Unions a. Bargains collectively with employers over wages, benefits, and working conditions b. Exert their market power to negotiate higher wages got workers c. When unions bargain successfully, wages and unemployment rise in that industry d. Typical union worker earns 20% higher wages and gets more benefits which is an incentive e. Examples: teachers union, and police union f. Insiders: workers who remain employed g. Outsiders are workers who lose their jobs h. Are unions good or bad? i. Unions are cartels. They raise wages above equilibrium which causes unemployment ii. Unions also counter the market power of large firms, make firms more responsive to workers concerns 3) Efficiency Wages a. Firms voluntarily pay above equilibrium to boost worker productivity b. Four reason i. Worker health- 1. This does not apply in the United States 2. This is in less developed countries, poor nutrition is a common problem. Paying Higher Wages allows workers to eat better, which makes them healthier and more productive ii. Worker turnover 1. Example: Restaurant Industry 2. Hiring and training new workers costs a lot. So paying higher wages gives them incentive to stay and reduces turnover. Wal-Mart and Starbucks both do this iii. Worker Quality 1. Offering higher wages attracts better job applicants, increases quality of the firms workforce a. Example is Nick Saban iv. Work Effort 1. Worker can work hard or be lazy. Shrikers are fired if caught Example of Structural and Frictional - Government eliminate the minimum wage o Structural - Government increase unemployment insurance benefits o Frictional but increase unemployment - A new law bans labor unions o Structural - More workers post their resumes on linkedin.com and more employers use linkedin.com to find suitable workers to hire o Reduces frictional unemployment - Sectoral shift becomes more frequent o Frictional but increase unemployment Explaining the Natural Rate of Unemployment - Consisits of o Frictional Unemployment Takes time to search for the right jobs Occurs even if there are enough jobs to go around o Structural Unemployment Wage is above equilibrium, not enough jobs to go around Due to minimum wages, labor unions, efficiency wages Chapter Summary - The unemployment rate is the percentage of those who would like to work who do not have jobs - Unemployment and labor force participation vary widely across demographic groups - The natural rate of unemployment is the normal rate of unemployment around which the actual rate fluctuates - Cyclical unemployment is the deviation of unemployment from its natural rate and is connected to short term economic fluctuations - Natural rate of unemployment include frictional and structural unemployment - Frictional unemployment occurs when workers take time to search for the right jobs - Structural unemployment occurs when above equilibrium wages result in surplus of labor o Wages laws, unions, efficiency wages Chapter 16 Econ Notes What is money and why is it important? - Without money, trade would require barter o Barter is the exchange of one good or service for another Not US economy Very costly - Most people would have to spend time searching for other to with - This is a huge waste of resources - This searching is unnecessary with money, the set of assets that people regularly use to buy goods and services from other people 3 Functions of Money - Medium of Exchange o Item buyers give to sellers when they want to purchase goods and services o Picking up and buying - Unit of account o The yardstick people use to post prices and record debts (dollars and cents) o Prices are recorded - Store of value (save) o Item people can use to transfer purchasing power from the present to the future o Investing and checking accounts are examples 2 Kinds of Money - Commodity money o Takes the form of a commodity with intrinsic value o Gold coin, diamonds, cigarettes in POW camps are examples o Has uses other than just money - Fiat Money o Money because the government says so o No intrinsic value o The US dollar is an example The Money Supply - Money supply o The quantity of money available in the economy o Also known as money stock - What assets should be considered part of the money supply? o Currency Paper bills and coins in the hands of non- bank public Not a good way to hold wealth You don’t earn interest and it could get lost or stolen o Demand Deposits Balances in bank accounts that depositors can access on demand by writing a check Checking account is an example Measures of the US Money Supply - M1- o Currency, demand deposits, travelers checks, and other checkable deposits - M2- o Everything in M1 plus savings deposits, small time deposits (CD under $100,000), money market mutual funds (write a check on it), and a few minor categories - M3- o M1 and M2 plus a large time deposit (over $100,000), repurchase agreements (repo), and other categories - The distinction between M1 and M2 will usually not matter when we talk about “ the money supply” in this course Central Banks and Monetary Policy - Central Bank o Institution that oversees the banking system and regulates the money supply - Monetary Policy o Setting of the money supply by policymakers in the central bank - Federal Reserve (FED) o The central bank of the US The Federal Reserve Organization - Created in 1913 from the Federal reserve act - After a series of bank failures in 1907 - “Panic of 1907” also called “Knickerbocker Crisis” - The purpose of the FED is to ensure the health of the nations banking system FED Organization Continued - Board of governors o 7 member with 14 year terms appointed by the president and confirmed by the senate o The chairman Directs the FED staff Presides over board meeting Testifies regularly about FED policy in front of congressional committees and nations Appointed by the president (4 year term) Janet Yellen is the current chairwoman o The FED system Federal reserve board is in Washington, DC 12 regional Federal Reserve Banks Closest one to T-Town is in Atlanta Major cities around the country The presidents- chosen by each banks board of directors Which state has two banks Missouri The FED’s Jobs Regulate banks and ensure the health of the banking system o Regional Federal Reserve Banks o Monitors each banks financial condition o Facilitates bank transactions- clearing checks o Acts as a banks bank Banks put their money into the FED o The FED- lender of last resort FED can bail out o Control the money supply Quantity of money available in the economy Monetary policy- their biggest job By Federal Open Market Committee (FOMC FOMC - 7 members of the board of governors - 5 of the twelve regional bank presidents o All twelve regional presidents attend each FOMC meeting, but only five vote o New York regional president always votes - Meets about every 6 weeks in Washington, DC o Discusses the condition of the economy o Consider changes in monetary policy The structure of the FED - Board of governors o 7 members - 12 regional FED banks o Located in the US - FOMC o Includes the 7 board of governors and 5 presidents of the regional FED banks Bank Reserves - Fractional reserve banking system o Banks keep a fraction of deposits as reserves and use the rest to make loans o This is what we have in the US - FED establishes Reserve Requirements o Regulations on the minimum amount of reserves that banks must hold against deposits. Banks can hold the reserves as vault or cash deposit at the FED - Banks hold more than this minimum amount if they choose - Reserve Ration o Fraction of deposits that banks hold as reserves o Total reserves as a percentage of total deposits Bank T- account - A simplified accounting statement that shows a banks assets and liabilities - Liabilities includes deposits, assets include loans and reserves - Reserves/ deposits The money Multiplier - The amount of money the banking system generates with each dollar of reserves - Money multiplier equal 1/ Reserve ration FED 3 tools of monetary control (how FED controls money supply) - Open Market Operations (OMO’s) o The purchase and sale of US government bonds by the FED o Buying and selling of government bonds o Increase money supply, FED buys government bonds, which are deposited in banks, increasing reserves o Which banks use to make loans, causing the money to expand o To reduce money supply, FED sells government Bonds, taking dollars out of circulation, and the process works in reverse o OMO’s are easy to conduct and are the FEDs monetary policy tool of choice - Reserve Requirements (RR) o Affect how much money banks can create by making loans o To increase money supply, FED reduces RR Banks make more loans from each dollar of reserves, which increases money multiplier and money supply o To reduce money supply, FED raises RR, and the process works in reverse o Fed rarely uses RR to control money supply Frequent changes would disrupt banking - Discount rate (don’t make loans to consumers) o Interest rate on loans the FED makes to banks o When banks are running low on reserves, they may borrow reserves from the FED o To increase money supply, FED can lower discount rate, which encourages banks to borrow more reserves from FED o Banks can then make more loans, which increases the money supply o To reduce the money supply FED can raise discount rate Federal Funds Rate - Banks with insufficient reserves can borrow from banks with excess reserves o Interest on the loans is the federal funds rate - The FOMC use OMO’s to target the FED funds rate - Many interest rates are highly correlated, so changes in the FED funds rate causes changes in other rates and have a big impact in the economy o Does not arbitrarily set the federal fund rate but can cause it to move Problems Controlling the Money Supply - if households hold more of their money as currency, banks have fewer reserves make fewer loans and the money supply falls - if banks hold more reserves than required, they make fewer loans and money supply falls o banks scared Banks runs and the money supply - Run on banks- people scared and go to bank to withdraw money - Under fractional reserve banks don’t have enough reserves to pay off all depositors hence banks may have to close - Banks make fewer loans and hold more reserves to satisfy depositors - These event increase the Reserve ratio - If banks collapse you are insured with your money Financial Crisis of 2008- 2009 - banks capital o resources a banks owners have out into the institution o used to generate profit - Leverage o Use of borrowed money to supplement existing funds for purposes of investment - Leverage ration o (reserves + Loans + securities)/ Capital - Capital requirement o Gov. regulation specifying a minimum amount of bank capital o Depends on the type of assets a bank holds o The safer the assets the lower the requirement - Safe asset- bonds - Risky asset- stocks - Shortage of capital o After they had incurred losses on some of their assets Mortgage loans Securities o Reduce lending (credit crunch) Contributed to a severe downturn in economic activity - US Treasury and the FED o Put many billions of dollars of public funds into the banking system To increase the amount of bank capital Called TARP o Temporarily made the US taxpayer a part owner of many banks o Goal: to recapitalize the banking system Bank lending could return to a more normal level Chapter 17 Macroeconomics Introduction Quantity theory of money o This chapter introduces this theory to explain one of the ten principles of economics o Prices rise when the government prints too much money Most economists believe the quantity theory is a good explanation of the long run behavior of inflation The Value of Money P is equal to Price Level (CPI or GDP Deflator) o P is the price of a basket of goods, measured in money 1/P is the value of $1 measured in goods o Example: bas
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