×
Log in to StudySoup
Get Full Access to UMass - ECON 104 - Class Notes - Week 3
Join StudySoup for FREE
Get Full Access to UMass - ECON 104 - Class Notes - Week 3

Already have an account? Login here
×
Reset your password

UMASS / Economics / ECON 104 / How the macroeconomy works by dividing it into four broad groups and d

How the macroeconomy works by dividing it into four broad groups and d

How the macroeconomy works by dividing it into four broad groups and d

Description

School: University of Massachusetts
Department: Economics
Course: Introduction to Macroeconomics
Professor: Gerald epstein
Term: Spring 2015
Tags: Economics, econ 104, Macro, intro to macro, Introduction to Macroeconomics, patrick dolenc, Study Guide, study guides, exams, and final exam
Cost: 25
Name: Exam Study Guides 1, 2, & 3
Description: these are all three filled out study guides for econ 104 for each of the three exams for the class. First exam, second exam and final exam
Uploaded: 02/15/2016
30 Pages 60 Views 2 Unlocks
Reviews


❖ Characteristics that define capitalism: 


How the macroeconomy works by dividing it into four broad groups and describing their interactions?



Define/Explain

capitalism ­ economic system in which goods are produced by employees and sold on markets for a profit

­ two characteristics:

1. WAGE LABOUR: people who produce goods & distribute the goods & services that make up our livelihood

a. paid for time they work by their employer hourly/ monthly wage ; annual salary do not own goods they produce

b. work under the direction of their employer

2. PRODUCTION FOR PROFIT: those who direct the production process do so with the intention to make profit by selling the output by selling the goods produced by workers at a price that exceeds the price to produce them If you want to learn more check out Who came up with tabula rasa?

Apply

In a capitalist economy, the wage labour of nike products would be wage workers in Taiwan being paid and working under the factory managers. The Production for product aspect of this economy


How we measure debt matters?



Evaluate

Capitalism is the first economic system where membership of elite depended on a high level of economic performance. Remaining in the club of the elite involved producing products that consumers wanted at prices lower than competitors. Capitalism explains the great hockey stick of history because owners had a lot to gain by introducing new technology to keep up with competition since it works through incentives in form of success and failure. We also discuss several other topics like What are the long bones in the leg?

❖ Compare/contrast international inequality of income (before and after taxes) 

pg 26

Different countries around the world & their tax policies (and their impact on income) Define/Explain

The different experiences with government intervention in different countries

countries w/ high inequality (pre­tax)

countries w/ low inequality (pre­tax)

less equalizing tax policy taxes that are flat/ everyone pays same rate

ex: social security

military

medicare

United States

Russia

United Kingdom

canada

tax policies are more

impacting of senior citizens insecure employment, job switching

no taxes to deal with issue

East Asian Countries — Taiwan

Japan

South Korea

corporations with lifetime employment and secure jobs

more equalizing tax policy ex: national healthcare policy free higher education

Continental Europe —

France

Germany

Belgium

Netherlands

insecure employment

in and out of jobs

taxes to deal with it

instead >> govt policies that assist w poor

Sweden

Norway

Finland

Denmark

the incomes and wages are not that different


How much more the banking systems can expand deposits?



If you want to learn more check out What are the key molecules for the continuity of life?

Columns equal differences in the degree of inequality in income and the rows equal differences in the extent in which taxes in government, transfers in income have on equalizing distribution of disposable income. If you want to learn more check out What are the 4 types of vertebrae?

Apply

(chart)

Evaluate

It is important to know this because these policies help to explain why capitalism functions better in some countries than others.(not necessary)

­

❖ Theory of the Invisible Hand 

Define/Explain

We can best understand the realm of political economy by having the understanding that people work out of self­interest behavior

­ self­interested behavior

­ we can best understand what’s going on if we believe that people act upon self interest

­ competitive markets

­ no buyer, seller, or single individual has an amount of power to control the market enough buyers & sellers to play fair

­ LEADS TO WHAT'S SOCIALLY OPTIMAL >>what’s best for everyone

Apply

ex:​Competing food places in town and the customers choice (When we spend money we are voting for what we want and the markets pay attention and the competitive nature decreases prices)

when there are multiple gyro places and no burrito place.

Opening burritos place would be socially optimal because it is what the people in the area would want and the owner would make money.

Evaluate

● Why we care ? Markets are best equipped to provide for society’s interest; if this true then the role of the government should be: Laissez Faire (hands off)

● The invisible hand is how markets function

❖ Opportunity Cost (including constant vs increasing) Don't forget about the age old question of What factors guided immigration and nationality policy during the colonial period?
If you want to learn more check out Is laissez faire capitalism good?

Explain/Define

the best alternative that we forgo/give up when we make a choice/decision ● when scarcity requires choices >> opportunity cost = next best option Apply

○ ex: going to class >> opportunity cost = sleep, breakfast, gym etc (one only!) ○ ex: adding this course >> opportunity cost = taking another class

Constant­ linear

Increasing­ Curve (longer you stick with the task the longer the time sacrifice) Evaluate

helps with the realization of unseen costs other than money such as time, energy and pleasure/utility.

❖ Absolute advantage vs comparative advantage 

Define/Explain

● Absolute advantage is reached when the production of a good uses fewer resources ○ who’s fastest

● Comparative advantage is reached when if a good can be produced at lower cost in terms of other goods

○ lowest opportunity cost

Apply

Absolute Advantage : (fastest)

potatoes ­ MI

cars ­ MI

Comparative Advantage: (lowest opportunity cost)

potatoes ­ ID

cars ­ MI

Evaluate

absolute advantages can produce a product or service using a smaller number of inputs and/or using a more efficient process than another party producing the same product or service. 

A comparative advantage gives a company the ability to sell goods and services at a lower price than its competitors and realize stronger sales margins. 

❖ Supply & Demand (determinants, contrasting movement vs shift)

Define/Explain

Supply

­ positive relationship between price and quantity of a good supplied ­ ceteris paribus: increase in market price will lead to an increase in quantity supplied

Determinants of Supply

­ cost of production

­ available technologies

­ prices/quantities of inputs

­ prices of related products

Supply ­

decrease>> shift to left

increase>> shift to right

­ Change in price of a good/service

­ >>Change in quantity demanded = movement along demand curve ­ Change in income, preferences/ prices of other goods/services

­ >>Change in demand = shift of a demand curve

Law of supply

­ an increase in the market price will lead to an increase in quantity supplied ­ decrease in market price will lead to a decrease in quantity supplied

Apply

Evaluate

❖ Market failures 

Explain/Define

When the market produces suboptimal outcome

causes; when the invisible hand creates outcomes that we don't want [collectively] 1. Public Goods

● non exclusive consumption

● ex: universal health care

○ Remedies:

■ non market allocation mechanism

■ collect taxes to find them

■ private membership

2. Equity

● markets are blind to fairness

○ ex: health insurance >> people who can afford better insurance receive better medical care

○ ex: malaria vs erectile disfunction >> people would rather pay more erectile dysfunction cure than malaria cure since people with less money are malaria victims and people with money are more

○ Remedies

■ non market allocation mechanism

■ rationing, first come first served

■ price controls (ceilings & floors)

3. Externalities

● refer to situation where transactions have spillover effects

● transactions affect 3rd parties

● when social costs differ from private costs, the discrepancy is an external cost ○ external costs matter but generally don't get included in production/transaction decisions

● 3rd parties that aren't participating are impacted (positive or negative) ● negative ­ cost is imposed on someone ]

● not socially optimal>> beneficial to individual/ small group not collective society ○ Remedies:

■ command & control (put rules in place)

■ internalize the externality by accounting for the costs within the

transaction

■ Pigouvian taxes

■ taxing discourages behavior

■ “one size fits all” >> multiple benefits inhibited behavior +

tax money to govt

■ Marketable Permits

■ selling permits to

■ ex: pollution from cars. car buyer + car seller = happy. 3rd

party unhappy being affected by pollution

4. Market Power

● the invisible hand works best when markets are competitive

○ ex: books

Apply

Public goods:

Equity: When businesses only invest in things that make them more money

Externalities: Paying for the Cigar and smoking it in the classroom negatively impacting everyone but the smoker themselves.

Evaluate

Market Failures are the outcomes of the invisible hand that defeat their purpose; they are NOT socially optimal. Economic and social policymakers try to consider the market failures that will result from specific legislation, and, in most cases, they ultimately attempt to minimize market

failure by finding a balance between protecting social (or political) interests and maintaining efficient markets.

❖ Contrasting real variables with their nominal counterparts Define/Explain

● nominal GDP ( Everything in one single number and is accomplished by using the GDP deflator)

○ prices & quantities

○ tells us what was priced based on time period

○ everything is in play at the same time

● Real GDP

○ quantities only

● Deflator

○ figures out whats going on in terms of prices

○ used to detect inflation

Apply

Evaluate

❖ Circular Flow Model 

Define/Explain

● Here goods and services flow clockwise: Labor services supplied by households flow to firms, and goods and services produced by firms flow to households. Payment (usually money) flows in the opposite (counterclockwise) direction: Payment for goods and services flows from households to firms, and payment for the labor services flows from firms to households

Apply

­

Evaluate

Helps to understand how the macroeconomy works by dividing it into four broad groups and describing their interactions.

❖ Role of government (i.e., fiscal policy vs monetary policy) Define/Explain

● In Macroeconomics the government has limited power but can affect the macroeconomy through the fiscal and monetary policies

● Fiscal policy refers to the government’s spending and taxing behavior also known as the budget policy. It’s divided into 3 categories:

1. policies concerning government purchases of goods and service

2. policies concerning taxes

3. policies concerning transfer payments (ex. Unemployment, social security) ● Monetary policy refers to the behavior of the nation’s central bank the federal reserve, concerning the interest rate (money supply of federal reserve)

Apply

­ interstate highways, military money,

Evaluate

To prepare for the short answer section of the exam, focus on three aspects of each topic:

1) Can you define/explain the concept including the use of appropriate graphs? 2) Can you apply the concept to a specific set of circumstances?

3) Can you evaluate the concept’s importance and/or its relationship to other material in the course?

Problem Solving Themes 

● Constructing and working with production possibilities graphs

● Calculating and working with opportunity cost data (including abs & comp adv.) ● Working with supply & demand graphs

supply and demand shifts

comparative & absolute advantage

max output

ppf graphs

Exam #2 Study Guide

The second exam will be from 7:00 – 9:00 p.m. on Monday, November 9thin Thompson 104 Don’t neglect the reading: chapters 6, 7, 8, & 9

Short Answer Topics 

Limitations of GDP 

Define & Explain

GDP is the total market value of a country’s output such as all final goods produced within a given period of time by factors of production located within a country.

GDP is an inaccurate measure of happiness or well­being. There are many factors that it fails to consider in measuring welfare.

­ household production

­ underground and illegal production

­ produced outcome not being measured

­ unofficial trade

­ leisure

­ ignores “bads” of society like crime and violence

­ decreases well­being

­ volunteer work

­ individuals could be working & producing outcome but GDP does not increase since they’re not getting compensated with money

­ increasing inequality

­ failure to distinguish the distribution of outcome

Apply

ex: Household production ­ most non market and domestic activities, such as housework and childcare, are not counted in GDP even though they amount to real production. However, if I decide to send my children to childcare or hire someone to clean my house or drive my car for me, GDP increases. Salaries of day care staff, cleaning people and chauffeurs are counted in GDP but the time I spend doing the same things are not. This is a mere change of institutional arrangements, even though no more output is being produced can show as a change in GDP.

Evaluate

GDP is not an effective measure of happiness, production and well being due to its shortcomings which makes determining/ making comparisons between time and countries very difficult and inaccurate. This is why other alternatives to measure a quality of life are coming about such as ­ genuine progress indicator

­ human development index

­ better life index

which factors in multiple aspects as units of measure.

Investment (components, determinants, graph, different uses) 

define/explain

The output of economy consists not only of goods consumed by households, but investments made by firms.

Planned Investment >>

● investment businesses take for future

● business expansion for more future sales

Actual Investment >>

● expenditures by firms (ex plant & equipment)

○ stuff firms plan to give

○ companies buying stuff to make more money

● new residential structures

○ new houses

● changes in business inventories

○ companies may accumulate stocks

○ maybe unintentional to have the amount of stock that is there>> planned to sell but didn’t happen

● used to measure GDP

Determinants of Planned Investment

1. Market Interest Rates (the cost of borrowing)

­ opportunity cost of using your own money

­ when interest rates increase planned investment decreases

2. Business expectations

­ what you think is going to happen

­ not relying on numbers >> gut

Evaluate

Alternatives to GDP 

define/explain

AS GDP increases, well­being does not necessarily increase along with it. We cannot assume that things are getting better (improved life conditions) just because more money is spent. Because GDP is an inaccurate unit of measure to determine quality of life and money doesn’t buy happiness, new methods to calculate this happiness are arising that consist of GDP accompanied by other factors.

1.) Genuine Progress Indicator

Effort to capture social aspects

a.) GDP

b.) measure of poverty

c.) environment

i.) pollution

ii.) crime

iii.) unpaid work

iv.) income distribution

2.) Human Development Index

a.) GDP

b.) Measures of education

i.) how educated the population is (grad rates)

c.) life expectancy

3.) Better Life Index

a.) GDP

b.) & Everything & Anything

i.) in principle this is the best but realistically it is difficult to get information

Apply

In the current environment where pollution and crime is increasing rapidly, GDP can still continue to go up, but this doesn’t mean that the quality of life is better. In fact, the quality would most likely be lower since the environment is creating difficulties such as harsh and unpredictable weather conditions and danger. While GDP does not consider these factors, GPI does.

Evaluate

The quality of life has deteriorated at an accelerating rate since 1970, the GPI went down as the GDP has went up. This is important because we need to be able to compare welfare more accurately.

Unemployment (interpreting graphs, various measures, types)

define/explain

In order to be considered unemployed, a person must be 16+ available for work and have made specific efforts to find work during the previous four weeks.

Unemployment can be categorized into three categories:

1.) Frictional Unemployment

a.) brief periods of unemployment experienced by people moving between jobs or into the labor market

i.) ex: getting fired > in between jobs

2.) Structural Unemployment

a.) unemployment caused by a mismatch between the skills/location of job seekers and the requirements/location of available jobs

i.) ex: outsourcing of factory work to other country

ii.) blacksmith / typewriter maker in 2015

3.) Cyclical Unemployment

a.) unemployment caused by macroeconomic conditions / business cycle b.) economy to blame

i.) recession

Apply

Frictional Unemployment

­ ex: getting fired > in between jobs

Structural Unemployment

­ ex: outsourcing of factory work to other country

­ blacksmith / typewriter maker in 2015

Cyclical Unemployment

­ job loss from recession

Evaluate

better assessment of unemployment

­ helps differentiate between those who will never get a job and those who will ­ helps figure how to help unemployed / solve crisis

Sources of inflation 

Define/explain

Inflation is an increase in the general/average price level of goods and services not a change in any specific price >>> prices going up, on average

1. Cost­ Push Inflation: caused by rising cost of production and real GDP declines ex. Oil Embargo (less common)

2. Demand­Pull Inflation: pulling prices up (too many dollars choosing too few goods) which is a boost to real GDP. This can lead to jobs and rising economic activity

Redistributive consequences of inflation 

Define/explain

inflation produces both winners and losers

● Price Effects

○ “what do you buy?”

○ people who tend to buy goods and services that are increasing in price the fastest end up with fewer goods and services

○ buyer goods whose prices inflate most hurts you most

■ ex:

■ buying technology = good

■ more quality given with price

■ higher education & healthcare = bad

■ higher price, maybe same quality

● Income Effects

○ “where does you income come from?”

○ people whose nominal income rise more slowly than inflation end up with fewer goods and services

■ ex:

■ drug companies vs minimum wage

■ drugs adjust to inflation yet minimum wages usually stays

the same

● Wealth Effects

○ “what do you owe/own?”

○ people who own assets that are increasing in real value end up with more real wealth

○ people who owe lose we

○ deflation devestates debtors

○ inflation=good for debtors

■ ex:

■ stocks

■ houses

Apply

Price effects

­ ex:

­ buying technology = good

­ more quality given with price

­ higher education & healthcare = bad

­ higher price, maybe same quality

Income Effects

­ ex:

­ drug companies vs minimum wage

­ drugs adjust to inflation while minimum wage does not

Wealth effects

­ ex:

­ stocks

­ houses

­ value goes up/down with inflation/deflation

Evaluate

Inflation can be good or bad depending on your relationship with economy

Paradox of Thrift 

Define/explain

paradox of thrift

­ the notion that individual savings rather than spending can worsen a recession/ is collectively harmful

­ an increase in planned saving causes equilibrium to decrease. The decreased consumption that accompanies increased saving leads to a contraction of the economy/output and to a reduction of income

­ at new equilibrium >> saving = same as it was at the initial equilibrium ­ increased efforts to save have caused a drop in income but no overall

change in saving

­ “paradoxical” because it contradicts the widely held belief that a “penny saved is a penny earned”

­ true for individual but not for whole society. When society as a whole saves more, the result is a drop in income but no increased saving.

Apply

­ person 1: income: $100 saves half > spending $50

­ person 2: income: $50 saves half > spending $25

­ person 3: income: $25 saves half > spending $12.5

­ less and less money being circulated in economy which eventually reduced income of everyone

Evaluate

­ this is just a theory

­ One of the main arguments against the paradox of thrift is that when people increase savings in a bank, the bank has more money to lend, which will generally decrease the interest rate and spur lending and spendings 

Automatic stabilizers and automatic destabilizers 

Define/explain

automatic stabilizer

­ revenue and expenditure items in the federal budget that automatically change with the economy in such a way as to stabilize GDP

­ in recessions, taxes fall and expenditures rise which create positive effects on the economy

­ If Y falls under aggregate expenditures/ if we have a recession, automatically stabilizers bring us back into balance

­ ex: transfer payments, social security, welfare >> anything that increases income of unemployed/poor/etc

automatic destabilizer

­ revenue and expenditure items in the federal budget that automatically change with the economy in such a way as to destabilize GDP

­ pushes economy away from balance

­ government spending increases as inflation increase > further fuels expansion > destabilizing

­ increase of inflation in a recession causes decrease in government spending, making a recession worse.

­ ex: volatile stock market/ financial system >> banks refusing to lend money

Apply

AS

­ ex: transfer payments, social security, welfare >> anything that increases income of unemployed/poor/etc

AD

­ ex: volatile stock market/ financial system >> banks refusing to lend money

Evaluate

automatic stabilizers

­ put money back into cycle to keep spending going which keeps economy stable automatic destabilizers

­ recessions are inevitable

­ shows that government spending isn’t exactly controllable

To prepare for the short answer section of the exam, focus on three aspects of each topic:

1) Can you define/explain the concept including the use of appropriate graphs? 2) Can you apply the concept to a specific set of circumstances?

3) Can you evaluate the concept’s importance and/or its relationship to other material in the course?

Problem Solving Themes 

● Working with macro data

(nominal GDP / Real GDP) x 100 = GDP Deflator

(new deflator­old deflator) / old deflator = Inflation Rate

● Working with the Keynesian Cross Model (one, two, and three sectors) One Sector

Y= C

Y = a + b (Yd)

Two Sector

Y = C + I

Y = a + b (Yd)

Three Sector

Y = C + I + G

Y = a + MPC (Y­T) + I + G

● Working with the multipliers (government spending, tax, and balanced­budget)

❖ Supply & Demand (determinants, contrasting movement vs shift) Define/Explain

Supply

­ positive relationship between price and quantity of a good supplied ­ ceteris paribus: increase in market price will lead to an increase in quantity supplied

Determinants of Supply

­ cost of production

­ available technologies

­ prices/quantities of inputs

­ prices of related products

Supply ­

decrease>> shift to left

increase>> shift to right

­ Change in price of a good/service

­ >>Change in quantity demanded = movement along demand curve

­ Change in income, preferences/ prices of other goods/services

­ >>Change in demand = shift of a demand curve

Law of supply

­ an increase in the market price will lead to an increase in quantity supplied ­ decrease in market price will lead to a decrease in quantity supplied

Apply

Evaluate

❖ Contrasting real variables with their nominal counterparts 

Define/Explain

● nominal GDP ( Everything in one single number and is accomplished by using the GDP deflator)

○ prices & quantities

○ tells us what was priced based on time period

○ everything is in play at the same time

○ Nominal also refers to measuring in current dollars where are all components of GDP are valued at their current prices but it is not a good measure of aggregate output over time because it can mislead in the growth of production due to something such as a price increase.

● Real GDP

○ quantities only

○ when nominal is adjusted for prices

● Deflator

○ figures out whats going on in terms of prices

○ used to detect inflation

Apply

Explain

❖ Limitations of GDP 

Define & Explain

GDP is the total market value of a country’s output such as all final goods produced within a given period of time by factors of production located within a country.

GDP is an inaccurate measure of happiness or well­being. There are many factors that it fails to consider in measuring welfare.

­ household production

­ underground and illegal production

­ produced outcome not being measured

­ unofficial trade

­ leisure

­ ignores “bads” of society like crime and violence

­ decreases well­being

­ volunteer work

­ individuals could be working & producing outcome but GDP does not increase since they’re not getting compensated with money

­ increasing inequality

­ failure to distinguish the distribution of outcome

Apply

ex: Household production ­ most non market and domestic activities, such as housework and childcare, are not counted in GDP even though they amount to real production. However, if I decide to send my children to childcare or hire someone to clean my house or drive my car for me, GDP increases. Salaries of day care staff, cleaning people and chauffeurs are counted in GDP but the time I spend doing the same things are not. This is a mere change of institutional arrangements, even though no more output is being produced can show as a change in GDP.

Evaluate

GDP is not an effective measure of happiness, production and well being due to its shortcomings which makes determining/ making comparisons between time and countries very difficult and inaccurate. This is why other alternatives to measure a quality of life are coming about such as ­ genuine progress indicator

­ human development index

­ better life index

which factors in multiple aspects as units of measure.

❖ Redistributive consequences of inflation 

Define/explain

inflation produces both winners and losers

● Price Effects

○ “what do you buy?”

○ people who tend to buy goods and services that are increasing in price the fastest end up with fewer goods and services

○ buyer goods whose prices inflate most hurts you most

■ ex:

■ buying technology = good

■ more quality given with price

■ higher education & healthcare = bad

■ higher price, maybe same quality

● Income Effects

○ “where does you income come from?”

○ people whose nominal income rise more slowly than inflation end up with fewer goods and services

■ ex:

■ drug companies vs minimum wage

■ drugs adjust to inflation yet minimum wages usually stays

the same

● Wealth Effects

○ “what do you owe/own?”

○ people who own assets that are increasing in real value end up with more real wealth

○ people who owe lose we

○ deflation devestates debtors

○ inflation=good for debtors

■ ex:

■ stocks

■ houses

Apply

Price effects

­ ex:

­ buying technology = good

­ more quality given with price

­ higher education & healthcare = bad

­ higher price, maybe same quality

Income Effects

­ ex:

­ drug companies vs minimum wage

­ drugs adjust to inflation while minimum wage does not

Wealth effects

­ ex:

­ stocks

­ houses

­ value goes up/down with inflation/deflation

Evaluate

Inflation can be good or bad depending on your relationship with economy

❖ Wolves, Pussycats, & Termites 

Define/Explain

Wolves Framework:

­Risk of inflation

­Risk of crowding out

­Political brinkmanship

Risk of Inflation: Price of goods/services go up on average and value of money is going down which leads to a deficit that require borrowing by selling bonds. Printing too much money can be inflationary. Look at the Demand Pull Inflation chart to describe this theory*

Crowding Out: When there is a scarcity of resource, if the demand comes from outside that resource will dwindle and those who can’t keep up get squeezed out and must go without that resource. Access to loanable funds chart in notes*

ex. Food for class on the last day from notes

Political Brinkmanship: pushing dangerous events to the brink of disaster to achieve the most advantageous outcome. The example of using debt ceilings which cap the amount treasury department could borrow. The wolves believe that broken relationship between the two political parties in D.C. can become an issue

Pussycats:

● context matters

○ who is the borrower?

■ US taxpayers

■ borrower's income?

■ US GDP

○ How we measure debt matters!

■ total debt: $18.42 trillion

■ publicly held debt: $ 13.42 trillion

■ gap= portion of debt held by government >>>big portion social security ○ International perspective

■ the debt GDP Ratio

■ how does the US compare?

● What about inflation?

● Crowding Out

○ more and more govt borrowing will deplete a scarce resource which increases the price of that resource (interest rate increases) which causes borrowers to be squeezed out

○ debt and inflation rate don't have connection

● Deficits as a policy tool

○ increasing taxes and decreasing spending make recessions worse

○ cutting taxes and increasing government spending = good >> deficit goes up

Termites

● future generations will curse us

● not a cyclical phenomenon

○ adding deficits continuously = bad

● what about the external debt?

○ internal debt: govt debt ( treasury bonds) hero by US household and institutions ○ external debt: US govt debt ( treasury bonds) held by foreign households and foreign institutions

● what did we buy?

● demographics of entitlements

● reduce confidence of investors

● longterm, if the government debt is too high, then the growth rates with decrease ● the austerity debate

Apply

Evaluate

All in regard to national debt and different frameworks in which you can see them and offer up solutions to the issues that they pose.

❖ Gresham’s Law

Define/Explain

● bad money drives out good

● artificially overvalued money tends to drive an artificially under valued money ● bad money drives out good money

Apply

ex:

● 2 quarters: one Canadian and one US >>> hold on to US

● 2 quarters: one old & one new >>> $2.50 store of value for old quarter and $0.25 for new due to silver percentage

Evaluate​:

● bad money gets spent and good money gets held back as store of value >> will disappear from circulation

● may resolve in source of inflation

❖ Categories of banking crises 

1. Liquidity problems (converting assets to money) :

a. This is when banks are having cash flow problems and there is a shortage of cash reserves. This can lead to a Bank Run which would involve individual bank struggles or a Bank Panic which a widespread effect on a number of banks. Other banks could help but this could cause them to suffer from helping and ideally competition wants you to fail.

b. Total Reserves= Required + Excess

c. The solution to this is the lender of last resort (federal reserve system) 2. Solvency Issues ( able to pay all legal debts) :

a. If a bank has negative net worth then it is insolvent “bad”.

b. Insolvency creates moral hazard so the solution to this issue is deposit insurance. FDIC intervene to help a bank by liquidating assets and paying off liabilities then put in FDIC funds to cover difference.

Evaluate

There needed to be an centralization of banking in order to help banks in time of crisis. The Federal Reserve Act of 1913 related the federal reserve and fragmented 12 banks regionally to manage these issues. Although it’s important to have a system in place for times of crisis they can also make the situation worse when the federal reserve for example made the great depression worse or their decision making isn’t accountable.

❖ Monetary policy stimulus (explaining the steps in words and with graphs) 

Explain/Define

1. the Fed employs policy tools

a. monetary policy

2. Banks increase lending

a. banks take excess reserves and lend more

3. the money supply increases

a. more money available

4. Interest rates decrease

a. increased money supply

5. Low interest rates >>> more investment ‘

a. ceteris paribus

6. more investment = more jobs

more jobs leads to the expansion of the economy

❖ Time Lags Regarding Monetary and Fiscal Policy 

Define/Explain

monetary and fiscal policy don't take effect right away when fed expands fiscal policy ­ taxing and spending controlled by congress

even though macroeconomic problem has been recognized and the appropriate corrective policies have been implemented, economy has to adjust to new conditions ­

Apply

Fiscal Policy:

One way to think about response lags in fiscal policy is through the government spending multiplier. This multiplier measures the change in GDP caused by a change in government spending or net taxes. It takes time for the multiplier to reach its full value, resulting in a lag between fiscal policy action and the time the full change in GDP is realized. This is due to the fact that extra government spending tends to not stimulate private spending. By the time the change is felt from the policy put into place the economy may be in a completely different state.

Monetary Policy:

Monetary policy works by changing interest rates which then have an effect on planned investment. The response of consumption and investment to interest rates takes time. The response lags for monetary policy is even longer than that of fiscal policy. When government spending changes, there is a direct change in the sales of firms, which sell more as a result of the

increased government spending. It takes time for household and firms to respond to interest rate changes. In this sense, interest rate changes are like tax­rate changes. The resulting change in firms’ sales must wait for households and firms to change their purchases of goods.

Evaluate

­ this is why stabilization is not easily achieved 

­ takes time for economists to recognize problem, more time for them to come up with a corrective policy, and most time for households and firms to respond to stabilization policies taken 

­ monetary policy changes­­ more quickly and easily adjustable to stabilizing economy ­ fiscal policy changes ­­ faster monetary response 

However, it is important to remember that monetary policy can exert an influence on the macro­economy even when interest rates are left unchanged. What matters is the level of interest rates. It is possible the cash rate may not have changed for some time but the level of interest rates is nonetheless exerting a strong expansionary or contractionary effect on the economy. 

❖ Moral Hazard and the Subprime Crisis 

● behavior that, on the individual level, is perfectly reasonable but that, earn aggregated in the marketplace, produces calamity

Subprime lending

● targeted at the riskiest borrowers

● important source for mortgage back security pools

● = 1/3 of US populations

Adjustable ­rate mortgages

● first issued in 1975 by California S &L1

● 5% of originations in 1980

○ 19/20 people chose fixed rate

● 64% of originations by 2006

○ 2/3 choose rate at the time over fixed

Mortgage secularization

● about 80% of all subprime mortgages were written as ARMs

2007

● US enters a recession

Early 2008

● National Association of Realtors announces largest drop om existing home sales in 25 years ● Fed Conhress [asses $168 billion stimulus

● march : Dow Jones lost 20% over 5 months

● March 16th Bear Stearns acquired in fire sale

September 2008

● Takeover of Fannie Mae & Fressie Mac

● Merril Lynch solf to Bank of America

● Lehman Brothers allowed to fail

● Fed lends $85 billion to AIG >> insurance company

When you combine a lack of regulation with cheap money>>>>>trouble

Define/Explain

­ recession>> devaluation of houses >> mortgage offenses >>

­ declining household spending & firm investment >> reduced money supply >> ­ contracting economy

Apply

­ SOLUTION : govt intervention

­ broadened role in baking system where it buys securities of Federal Agency of Debt secuirty

Evaluate

the subprime crisis is where the government began intervening with financial institution. The moral hazard becomes whether or not it is right for the government to get involved and whether this relieves or encourages the issue.

Problem Solving Themes

❖ Working with bank balance sheets 

❖ Working with the money multiplier 

Money Multiplier

1/required reserve ratio

● rate at which new deposits leak out of system and into reserve

Potential Deposit Creation

(moneymultiplier)(excess reserves)

● how much more the banking systems can expand deposits

Monetary Policy and Balance Sheet

rrr= .25

Assets Liabilities + NW

Cash 800,000 Deposits 1,000,000

Loans 250,000 Bank Capital 200,000 Bonds 150,000

TOTAL: 1,200,000 TOTAL: 1,200,000

a. what are the required reserves of this bank ?

● total reserves= cash

● (rrr)(deposits) = (.25)(1,000,000) = 250,000

b. what are the excess reserves?

A. cash ­ required reserves

B. 800,000 ­ 250,000 = 550,000

c. calculate the money multiplier ?

● 1/.25

● 4

d. Assume that FOMC uses expansionary open market operations and that this bank participates completely. Draw the new balance sheet

● liquidate bonds >>

● new cash = 950,000

● new bonds = 0

e. calculate potential deposit creation

● new excess reserves = 950,000­ 250,000= 700,000

● (excess reserves)(money multiplier) = 700,000(4) = 2,800,000

Page Expired
5off
It looks like your free minutes have expired! Lucky for you we have all the content you need, just sign up here