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EC 111 Unit 3 study guide

by: Conner Jones

EC 111 Unit 3 study guide EC 111

Conner Jones
GPA 4.0

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Zirlott EC 111 unit 3 study guide
Principles of Macroeconomics
Study Guide
EC 111 zirlott unit 3 study guide
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This 4 page Study Guide was uploaded by Conner Jones on Thursday April 14, 2016. The Study Guide belongs to EC 111 at University of Alabama - Tuscaloosa taught by Zirlott in Spring 2015. Since its upload, it has received 64 views. For similar materials see Principles of Macroeconomics in Economcs at University of Alabama - Tuscaloosa.


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Date Created: 04/14/16
EC 111 Unit 3 Study Guide Formulas:  Money Multiplier = 1/R o R = reserve ratio  Value of money = 1/P o P = price level  Velocity of money = (P x Y)/MS o P = price level o Y = real GDP o MS = money supply  Nominal GDP = P x Y o P = price level o Y = real GDP  Quantity equation: MS x V = P x Y o V = velocity  Net Exports (NX) = value of exports – value of imports  NCO = NX o NCO = net capital outflow o NX = net exports  S = I + NCO o S = national savings o I = domestic investment o NCO = net capital outflow  Real exchange rate = (nom. Exchange rate) x (domestic cost of basket/foreign cost of basket) Key terms:  Medium of exchange – an item buyers give to sellers when they want to purchase goods  Unit of account – yardstick people use to post prices and record debts  Store of value – an item people can use to transfer purchasing power from present to the future  Commodity money – has uses besides being money (gold, diamonds)  Fiat money – just money because government says so (US dollar)  Money supply (money stock) – amount of money in the economy; it includes: currency (paper bills, coins) and demand deposit (checking account) o M1 – currency, demand deposits, and other checkable deposits o M2 – everything in M1 plus savings deposits, money market funds, and small time deposit (certificate of deposit under $100,000 o M3 – M1 and M2 plus large time deposits (certificate of deposit over $100,000), repurchase agreements  Central banks – an institution that oversees the banking system and regulates the money supply  Monetary policy – the setting of the money supply by policymakers in the central bank  Federal reserve – the central bank of the US (created in 1913 after bank failures in 1907, Panic of 1907 o 3 tools of the fed: open market operations, reserve requirement, discount rate o Made up of 7 members o Made up of 12 fed reserve banks, closest one in Atlanta o Fed is the bank of the banks o Controls money supply by setting monetary policy  Federal Open Market Committee (FOMC) – 12 members, meet every 6 weeks in Washington DC, discuss economy and monetary policy  Fractional reserve banking system – banks keep a fraction of deposits as reserves and uses the rest to make loans  Reserve ratio – fraction of deposits banks must hold in reserves  T Account – shows a simplified accounting statement that shows a bank’s assets and liabilities  Open market operations (OMO’s) – the purchase and sale of US government bonds by the fed o To increase money supply fed buys government bonds o To decrease money supply fed sells government bonds  Reserve requirement (RR) – amount of money banks are required to keep in reserves and not loan out o To increase money supply fed decreases the reserve requirement o To decrease money supply fed increases the reserve requirement  The discount rate (DR) – the interest rate on loans the fed makes to banks o To increase money supply fed decreases discount rate (encourages banks to borrow more reserves from fed) o To decrease money supply fed increases discount rate (discourages banks from borrowing more reserves from fed)  Federal funds rate – interest rate that banks charge another bank  bank run – when people get scared, suspect their bank is in trouble, and withdraw all of their funds  leverage – use of borrowed money to supplement existing funds for purposes of investment  leverage ratio – (reserves + loans + securities) / Capital  capital requirement – government regulation specifying a minimum amount of bank capital  quantity theory of money – prices rise when the government prints too much money (long run inflation)  nominal variables: measured in monetary units (ex: hourly wage, price)  real variables: measured in physical units (ex: real GDP, what you can buy with wage)  classical dichotomy – the theoretical separation of real and nominal variables; says that if central bank doubles money supply nominal variables such as wage will double but real variables will remain unchanged  monetary neutrality – the proposition that changes in the money supply that do not affect real variables  hyperinflation – caused by the government printing way too much money and the inflation rate exceeds 50% a month  the inflation tax – when government prints money it causes inflation, the loss in value of currency is called inflation tax  the fisher effect – in the long run, money is neutral so a change in money growth rate affects the inflation rate but not the real interest rate  shoeleather costs – the resources wasted when inflation encourages people to reduce their money holdings  menu costs – the costs of changing prices  tax distortions – inflation makes nominal income grow faster than real income  closed economy – does not interact with other economies around the world  open economy – interacts freely with economies around the world  types of trade: o trade deficit – excess of imports over exports o trade surplus – excess of exports over imports o balanced trade – exports = imports  net capital outflow (NCO) – domestic residents’ purchases of foreign assets minus foreigners’ purchase of domestic goods (also called net foreign investment)  foreign direct investment – domestic residents/firms set up a foreign subsidiary (ex: McDonalds opens outlet in Moscow, Disney builds theme park in Hong Kong)  foreign portfolio investment – domestic residents purchase of foreign stocks or bonds (ex: American buying stock in Toyota)  nominal exchange rate – the rate at which one country’s currency trades for another country’s currency  real exchange rate - the rate at which goods and services of one country trade for goods and services of another country  Purchasing power parity (PPP) – a theory of exchange rates whereby a unit of any currency should be able to buy the same quantity of goods in all countries Key diagrams:


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