Macro Exams Bundle
Macro Exams Bundle EC 111
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Macro Exams Bundle Macro Economics Exam 1 Study Guide Chapter 1 What is the study of economics? - The study of how society manages its scarce resources o How people decide what to buy, how much to work, save, and spend o How firms decide how much to produce, how many workers to hire o How society decides how to divide its resources between national defense, consumer goods, protecting the environment, and other needs - What is microeconomics? - Microeconomics- is the study of how households and firms make decisions and how they interact in markets What is 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 What is equity/ equality? - When prosperity is distributed uniformly among society’s members: Every one gets an equal share What is scarcity? - the limited nature of society’s resources What is efficiency? - When society gets the most from its scarce resources 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 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 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 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 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 What is a market and market economy? - Market: A group of buyers and sellers (need not be in a single location) o Example: Internet, Stock Exchange - Market Economy allocates resources through the decisions of many households and firms as they interact in markets What is the “invisible hand”? - 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 What is market failure? 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 Chapter 2 - - Model: a highly simplified representation of a more complicated reality o Economists use these models to study economic issues 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 Chapter 4 (THIS CHAPTER IS THE MOST IMPORTANT) 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 What is price elasticity of demand? - 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 Why is calculating elasticity better when using the midpoint methods - because it is the easiest and you only need two points on the graph 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 elasticity? - 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 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 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 Complements are less than zero EXAM 2 Study Guide Ch. 10 GDP 1. What is GDP? a. Measures the total income of everyone in the economy b. Measure the total expenditure on the economy’s output of goods and services 2. How do you calculate GDP? What are the four components of GDP? Examples of items for each component. a. How to be calculated. i. Y= C + I + G+ NX b. Four Components Consumption © o Total spending by households on goods and services o Spent by yourself o Housing Costs For Renters Consumption includes rent payments and is included in GDP For Homeowners – lives in house Consumption includes the imputed rental value of the house, but not the purchase price or mortgage payments Investment (I) o Total spending on goods that will be used in the future to produce goods o 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) Government Purchases (G) o is all the spending on the goods and services purchased by government at the federal, state, and local events. o They exclude transfer payments such as Social Security or unemployment insurance benefits Net Exports (NX) o Exports represent foreign spending on the economy’s goods and services o Foreign people buying our goods o 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 3. What goes into the calculation of GDP? What does not go into the calculation of GDP? And why? 4. Calculate Nominal GDP, Real GDP, and the GDP Deflator. a. Real VS. Nominal GDP i. Inflation can distort economic variables like GDP, so they have two versions of GDP 1. One is corrected for inflation, the other is not ii. Nominal GDP 1. Values output using current prices 2. Is not corrected for inflation 3. Current output and current prices iii. Real GDP 1. Values output using the prices of a base year 2. Corrected for inflation 3. Current input and base year price is fixed 5. Using the GDP Deflator to compute the inflation rate. GDP Deflator a. Measure of overall level of prices b. GDP= 100 x (nominal GDP/ real GDP) 6. Problems with GDP as a Measure of Economic Well-Being. a. Having a larger GDP enables a country to afford better schools, a cleaner environment, health care b. Many indicators of the quality of life are positively correlated with GDP i. Life expectancy ii. Literacy iii. Internet usage and technology Ch. 11 CPI 1. The 5 steps for creating the CPI Index and calculating the inflation rate. a. Fix the “basket”- any store i. The Bureau of Labor Statistics (BLS) surveys consumers to determine what’s in the typical consumer’s shopping basket b. Find the prices i. The BLS collects data on the prices of all the goods in the basket c. Compute the basket’s cost i. Use the prices to compute the total cost of the basket d. Choose a base year (base year is given) and compute the index i. CPI in any year equals 1. 100 x (Cost of basket in current year/ cost of basket in base year) e. Compute the inflation rate i. The percentage change in the CPI from the preceding period 1. Inflation Rate= ((CPI this year- CPI last year)/ (CPI last year)) x 100% ii. (New-old)/ old 2. Calculating the CPI Index given a fixed basket and prices. a. How CPI is calculated (have to go in order) i. Fix the “basket”- any store 1. The Bureau of Labor Statistics (BLS) surveys consumers to determine what’s in the typical consumer’s shopping basket ii. Find the prices 1. The BLS collects data on the prices of all the goods in the basket iii. Compute the basket’s cost 1. Use the prices to compute the total cost of the basket iv. Choose a base year (base year is given) and compute the index 1. CPI in any year equals a. 100 x (Cost of basket in current year/ cost of basket in base year) v. Compute the inflation rate 1. The percentage change in the CPI from the preceding period a. Inflation Rate= ((CPI this year- CPI last year)/ (CPI last year)) x 100% b. (New-old)/ old 3. Problems with the CPI Index and Measuring the Cost of Living (Substitution Bias, Intro of New Goods, Unmeasured Quality Change). 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 4. Differences between the CPI Index and the GDP Deflator. a. Imported Consumer goods i. Included in CPI ii. Excluded from GDP Deflator b. Capital Goods (investment goods) i. Excluded from CPI ii. Included in GDP Deflator (produced domestically) c. The Basket (doesn’t change, all currently produced stuff) i. CPI uses fixed basket (updated every 5 years) ii. GDP Deflator uses basket of currently produced goods and services (updated automatically) d. They both measure inflation but in different ways 5. Correcting Variables for Inflation (How to calculate this correction?) a. Amount in todays dollars = Amount in year T dollars X (Price level today/ Price level in year T) b. Example: i. CPI in year T= 31.3, CPI= 220.3 today ii. Min wage was $1.15 in year T iii. $1.15 x (220.3/31.3)= $8.0 6. Used to see how a variable has changed over time after correcting for inflation a. A dollar amount is indexed (changes toward inflation) for inflation if it is automatically corrected for inflation by law or in a contract b. Increase in the CPI automatically determines i. The COLA in many multi- year labor contracts ii. The adjustments in Social security payments and federal tax brackets 7. Real versus Nominal Interest Rate a. The Nominal i. Interest rate not corrected for inflation ii. The rate of growth in the dollar value of a deposit or debt b. Real interest rate i. Corrected for inflation ii. The rate of growth in the purchasing power of a deposit or debt c. Real interest rate i. Nominal interest rate- inflation rate d. Real rate of growth= real interest rate Ch. 13 Financial System in a Closed Economy 1. What are Financial Markets? Examples of them. (Bonds and Stocks) a. Financial Markets i. Institutions through which savers can directly provide funds to borrowers b. The Bond Market i. A bond is a certificate of indebtness c. The Stock Market i. Stock is a claim to partial ownership in a firm 2. What are Financial Intermediaries? Examples of them. (Banks and Mutual Funds) a. Financial Intermediates i. Institutions through which saver can indirectly provide funds to borrower b. Examples: Banks i. Mutual funds (mortgage) 1. Institutions that sell shares to the public and use the proceeds to buy portfolios of stocks and bond 3. National Income Identity for a Closed Economy - is the portion of national income that is not used for the consumption or government purchases 4. What are Private Saving, Public Saving, Budget Deficit, Budget Surplus, and National Saving? 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 5. What is National Savings equal to for a closed economy? a. Saving is equal to investment in a closed economy i. Closed economy do not trade with outside world 6. Calculating the various types of savings using the National Income Identity. Government Spending 2 Consumption (C) 6.5 GDP (Y) 10 Budget Deficit .3 A) Find public savings (public saving is equal to budget deficit just with a negative sign in front of it. a. -.3 B) Find Taxes a. T= G-.3 b. T= 2 - .3 c. T= 1.7 C) Find private savings a. Y – T – C= 10 – 1.7 – 6.5 b. = 1.8 D) Find national saving a. Y – C – G= 10 – 6.5 – 2 b. = 1.5 E) Find investment (investment is equal to national savings) a. = 1.5 7. The Market for Loanable Funds 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 8. What does the Supply and Demand for Loanable Funds represent? a. Supply represents the interest rate. b. Demand represents the loanable funds 9. Why does Supply of LF slope upward? Why does Demand for LF slope downward? - Supply of loanable funds slopes upward because at a higher interest rate individuals get a higher return on their money and are willing to save more - Demand of loanable fund slopes downward because at a lower interest rate firms and individuals can borrow money more cheaply 10. What shifts the Supply and Demand Curves for 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 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 11. How do Savings Incentives, Investment Incentives, and Budget Deficit affect the Market for Loanable Funds and the Interest Rate? 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 12. Crowding Out Effect a. Crowding Out: i. The government borrows to finance its deficit, leaving less funds available for investment Ch. 15 Unemployment 1. What is the Labor Force? Who is included in the Labor Force? Who is not included in the Labor Force? a. Labor force- the total number of workers, including the employed and unemployed b. Based on “adult population” i. The adult population is 16 years or older ii. Minor is below c. The BLS is divided into three groups i. 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) ii. Unemployed – people looking for work 1. 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 iii. Not in the Labor force- everyone not looking for a job, (minor 1. Minors, retirees, inmates, full time students, disabled people, discouraged workers (people not looking for a job), illegal immigrants 2. Calculating the Labor-Force Participation Rate and the Unemployment Rate. a. U-Rate (unemployment rate)- percent of the labor force that is unemployed i. 100 X (number of unemployed/ labor force) b. Labor force participation rate- percent of the adult population that is in the labor force i. 100 X (labor force/ adult participation) 3. Problems with the Unemployment Rate. a. 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 4. What is the Natural Rate of Unemployment and what is it composed of? a. Natural rate of unemployment i. The normal of unemployment around which the actual unemployment rate fluctuates b. There is always some unemployment c. Frictional unemployment- time it takes to find a job i. Occurs when workers spend time searching for the jobs that best suit their skills and tastes ii. Short term for most workers d. Structural unemployment – not enough jobs to go around i. Occurs when there are fewer jobs than workers ii. Usually longer term e. Both are reasons why we have a natural rate of unemployment and are both made up of three things 5. What is Cyclical Unemployment? a. Cyclical i. The deviation of unemployment from its natural rate ii. Associated with business cycle 6. What is Frictional Unemployment? What are the causes of Frictional Unemployment? (Job Search, Sectoral Shifts, Unemployment Insurance) 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 7. What is Structural Unemployment? What are the causes of Structural Unemployment? (Minimum Wage Laws, Unions, Efficiency Wages) 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 Macro Exam 2 Formula Sheet GDP o Y = C + I + G +NX o Y = GDP o C = Consumption o I = Investment o G = Government Purchases o NX = Net Exports = Exports – Imports o Export- Foreign people buying our stuff o Import- we are buying foreign stuff GDP Deflator- measure of overall level of prices o 100 X (Nominal GDP/ Real GDP) o Real GDP o Values output using prices of a base year o Nominal GDP o Values output using current prices CPI Calculation o 100 X (cost of basket in current year/ cost of basket in base year) Inflation Rate = ((CPI this year- CPI last year)/ (CPI last year)) X 100% = (New- Old)/Old Private Savings- income that is not used for consumption or paying taxes = Y – T – C o Y = GDP o T = Taxes o C = Consumption Public Savings- tax revenue is less than government spending = T – G o T = Taxes o G = Government Purchases National Savings = Private saving + Public savings = (Y – T – C) + (T – G) = Y – C – G Saving and Investment o Saving is equal to investment in a closed economy o I = Y – C – G Budget Surplus = T – G = Public saving (positive) Budget Deficit = G – T = Public saving just negative Unemployment Rate (U- Rate) = 100 (Number of Unemployed/ Labor Force) Labor Force Participation Rate o Percent of the adult population that is in labor force o = 100 X (Labor Force/ Adult Population) Labor Force o Employed + Unemployed Population o Labor Force + Not In Labor Force Macro Exam 3 Study Guide Chapter 16 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 Types 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 M1, M2, and M3 - 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 Structure of the Federal Reserve System - Purpose of the FED is to ensure the health of the nations banking system - 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 o 7 members of the board of governors o 5 of the twelve regional bank presidents All twelve regional presidents attend each FOMC meeting, but only five vote New York regional president always votes o Meets about every 6 weeks in Washington, DC Discusses the condition of the economy Consider changes in monetary policy - The structure of the FED o Board of governors 7 members o 12 regional FED banks Located in the US o FOMC Includes the 7 board of governors and 5 presidents of the regional FED banks 3 Tools of the Fed, how they work and how they are used - 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 Types of Banking Systems 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 Commercial bank - Depository banks that accepted deposits and are covered by deposit insurance Investment Bank - Banks engaged in creating and trading financial assets such as stocks and corporate bonds but were not covered by deposit insurance because of their riskiness of their activities How does a bank create money? - The money Multiplier o The amount of money the banking system generates with each dollar of reserves o Money multiplier equal 1/ Reserve ration Financial Crisis 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 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: basket contains one candy bar P= $2, value of $1 is ½ candy bars Inflation drives up prices and drives down the value of money Graphs Money Supply o MS is determined by Federal Reserve, the banking system, and consumers in the real world o We assume the FED precisely controls MS and sets it at some fixed amount Money Demand – how much cash you hold o Refers to how much wealth people want to hold in liquid for Most liquid form is cash o Depends on P An increase in price level reduces the value of money, so more money is required to buy goods and services o The quantity of money demanded is negatively related to the value of money and positively related to P, other things equal o If prices levels rise you have to pay more Money Supply Diagram FED sets MS at some fixed value o 1 – perfectly inelastic If Fed precisely fix the MS then it is perfectly inelastic As the price level falls the value of money rises Demand for money is like the traditional demand curve, which is downward sloping P adjusts to equate quantity of money demanded with money supply Calculating Relative Price Relative Price o Price of one good relative to (divided by) another Example Price of a CD is $15 Price of a pizza $10 CD in terms of Pizza 15/10= 1.5 pizzas per cd o Measured in physical units, so they are real variables Calculating Real Wage W= nominal wage= price of labor P= price level= price of goods and services Real wage is the price of labor relative to the price of output o W/P Real Vs. Nominal Variables Nominal Variables measured in monetary units o Examples: Nominal GDP, nominal interest rate (rate of return measured in $), nominal wage ($ per hour worked), minimum wage Real Variables – measured in physical units o Examples: Real GDP, real interest rate (measured in output), real wage (measured in output) What can you buy with wage Classical Dichotomy and Money Neutrality Classical dichotomy nominal and real don’t interact o Theoretical separation of nominal and real variables Hume and the classical economists suggested that monetary developments affect nominal variables but not real If the central bank double the MS, Hume and classical thinkers contend o All nominal variables including prices will double o All real variables including relative prices will remain unchanged Monetary Neutrality o The proposition that changes in the money supply do not affect real variables Doubling the MS causes all nominal prices to double Most economists believe the classical dichotomy and neutrality of money describe the economy in the long run Calculating Velocity of Money The Velocity of Money the rate at which money changes hands V= (P x Y)/ M (P x Y) is nominal GDP M is the money supply V is velocity Quantity Equation M x V = P x Y o Represents entire economy The quantity theory in 5 steps o V is stable o So, change in M causes nominal GDP to change by the same percentage M goes up 10% then GDP goes up 10% o A change in M does not affect Y Money is neutral when it comes to real output Y is determined by technology and resources o So, P changes by the same percentage as P x Y and M o Rapid money supply growth cause rapid inflation Costs of Inflation Hyperinflation o Defined as inflation exceeding 50% per month o Prices rise when the government massively prints too much money o Excessive growth in the money supply always causes hyperinflation The Inflation Tax o when tax revenue is inadequate and ability to borrow is limited, government may print money to pay for its spending o the revenue from printing money is called inflation tax The Fisher Effect o Nominal interest rate = inflation rate + real interest rate o In long run money is neutral, so a change in the money growth rate affects the inflation rate but not the real interest rate o The nominal interest rate adjusts one for one with changes in the inflation rate Inflation fallacy most people think inflation erodes real incomes or their purchasing power Shoe leather Costs the resources wasted when inflation encourages people to reduce their money holdings how much cash you hold o Includes the time and transactions costs of more frequent bank withdrawals Menu Costs o Costs of changing prices o Printing new menus, mailing new catalogs Higher inflation causes more frequent price changes which leads to higher menu costs Misallocation of Resources from Relative price variability Firms don’t all raise prices at the same time, so relative prices can vary.. Which distorts the allocation of resources Confusion and Convenience Inflation changes the yardstick we use to measure transactions Tax Distortions o Inflation makes nominal income grow faster than real income o Taxes are based on nominal income and some are not adjusted for inflation o So inflation causes people to pay more taxes even when their real incomes don’t increase Arbitrary redistributions of wealth o Higher than expected inflation transfers purchasing power from creditors to debtors; Debtors get to repay their debt with dollars that aren’t worth as much o Lower than expected inflation transfers purchasing power from debtors to creditors o High inflation is more variable and less predictable than low inflation o These arbitrary redistributions are frequent when inflation is high After Tax Nominal and Real Interest Rates Chapter 18 Net Export, Trade Balance, Trade Surplus, Trade Deficit - Trade Surpluses and Deficits o Net Exports measures the imbalance in a countries trade in goods and services Trade Deficit Excess of imports over exports, NX < 0 and Y < C + I + G Trade Surplus Excess of exports over imports, NX > 0 and Y> C + I + G Balance Trade Exports = imports, NX = 0 and Y = C + I + G - Exports o Domestically produced goods and services sold abroad - Imports o Foreign produced goods and services sold domestically - Net Exports or the Trade balance o Exports – imports What are NCO, capital outflow, and capital inflow? - NCO measures the imbalance in a country’s trade in assets o When NCO is positive “capital outflow Domestic purchases of foreign assets exceed foreign purchases of domestic assets o When NCO is negative = to “capital inflow” Foreign purchases of domestic assets exceed domestic purchases of foreign assets Foreign Direct Investment VS Foreign Portfolio Investment - Net capital outflow (NCO)- Flow of assets o Domesic residents purchases of foreign assets o Foreigners purchases of domestic assets - NCO is also called net foreign investment - Two Forms o Foreign direct investment Set up foreign subsidiary and actively manage the foreign investment o Foreign Portfolio investment Purchase foreign stocks or bonds, supplying “loanable funds” to a foreign firm, such as an American buys stock in Toyota Factors that affect NX and NCO - NCO = NX - Variable that influence NCO o Real interest rates paid on foreign assets o Real interest rates paid on domestic assets o Perceived risks of holding foreign assets o Government policies affecting foreign ownership of domestic assets National Income and National Savings Identities for an Open Economy - National Income Identity o Y= C+ I+ G+ NX - In an open economy o S= I+ NCO Saving = Investment + NCO - NX= NCO - S-I = NCO o Positive, and capital will flow out of the country - When S>I then NCO>0 and the excess loanable funds flow abroad in the form of positive net capital outflow o Trade Surplus - The opposite, foreigners are financing some of the country’s investment in the form of negative net capital outflow o Trade Deficit Nominal Exchange Rate - Nominal Exchange Rate; o Rate at which one country’s currency trades for another - We express all exchange rates as foreign currency per unit of domestic currency
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