Final Exam Notes
Final Exam Notes ECN 222 - 005
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This 17 page Study Guide was uploaded by Abigail Johnson on Wednesday April 20, 2016. The Study Guide belongs to ECN 222 - 005 at University of North Carolina - Wilmington taught by Adam Talbot Jones in Spring 2016. Since its upload, it has received 35 views. For similar materials see Macroeconomics in Economcs at University of North Carolina - Wilmington.
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Date Created: 04/20/16
4/6/16 3:14 PM TEST MONDAY WEDNESDAY April 6, 2016 Dictator problem: took farms question… problem of property rights à GDP falls and stays low. CPI vs. GDP deflator… CPI is household cost of living (can only use when you know what’s in the “basket”)… GDP deflator if no basket th Next HW bonus (10pts) –chancellor’s lecture series. Tuesday 12 4-5pm in Burney Center • Take a selfie and upload to BB KINDS OF SAVINGS Private Savings: the income remaining after households pay their taxes and pay for consumption. (gets matched with the borrowers) “Y-T-C” [total, minus tax, minus consumption] • Can buy stocks or bonds • Purchase certificate of deposit at a bank • Mutual fund shares • Let sit in checking/savings Saving is NOT Investment Public Savings: The govn’t equivalent of private savings. Tax revenue minus govn’t spending “T-G” National Savings: Sum of Public and Private savings. [(Y-T-C)+(T-G)] à Y- C-G Which is the portion of national income remaining after household consumption and govn’t purchases. GDP: Y=C+I+G+NX • Assume a “closed economy” (no int’l trade) (Strong Assumption at national level; Weak Assumption at global level) • à Y=C+I+G o Solve for I: I=Y-C-G (National Savings) o For a closed economy, National Savings = GDP, or Savings = Investment Budget Surplus: an excess of tax revenue over govn’t spending (not spending as much as receiving in taxes) • T-G>0 • = Public Saving Budget Deficit: a shortfall of tax revenue from govn’t spending (spending more than receiving in taxes) • T-G<0 • = - (public saving) or “negative public saving” Suppose the govn’t cuts taxes by $200b, but govn’t expenditures remain unchanged. o In each of the following scenarios, determine what happens to public saving, private saving, national saving, and investment. § Consumers save the full proceeds of the tax cut. • 200b tax cut, G unchanged • NS= (Y-T-G) + (T-G) • Private savings increases by 200b, and government saves less 200b (keeps NS the exact same) § Consumers save ¼ of the tax cut and spend the other ¾ • 200b tax cut, G unchanged • NS= (Y-T-G) + (T-G) • C increases by 150b • T-G: decrease by 200 b • Private savings increase by 50b • So, NS decreases by 150b, so national investment decreased as well (I) Market for Loanable funds: a Supply-Demand model of the financial system • Assume: only one financial market (only one vault with all the $$) • Assume: all borrowers take out loans from this market and all savers deposit into this market o Demand for loans is demand for investment o Supply from National Savings • Assume: one interest rate, which is both the return to saving and the cost of borrowing The Model of Loanable Funds • Price=Interest Rate • Quantity of loanable funds • S curve = National Savings • D curve = demand for investment • At Equilibrium, NS=I Policies 1. Saving Incentive: A saving incentive could be a tax break for personal income taxes encouraging saving • 401K, 403b, IRA, etc. • Households will save more at every interest rate • Savings accumulating in bank vaults • Affects S curve, shifts right • Interest rates decrease and quantity increases 2. Investment Incentive: reduces the taxes of firms making investment • an increase in the incentive to invest • more firms want to invest, which has more loans taken from banks • Demand curve shifts right • Interest rate increases, quantity increases Use model of loanable funds to analyze the effects of a govn’t budget deficit: • NS decreases, so S curve shifts Left • Interest rate increases, quantity decreases = crowding out 4/15/16 9:00 PM MONDAY April 11, 2016 Savings and Investment Chapter Aplia Assignment (due wed ) Make up assignment on BB (video + Q’s + Aplia) under the “unemployment” module • Unemployed: must be over 16, no job, but actively seeking job within last 4 weeks • Not in labor force: don’t suffice any one qualification for unemployed • Unemployment rate: (# unemployed/# in the labor force)*100 • Labor Force Participation Rate: (# in labor force/adult pop.)*100 Savings comes from National Savings Demand is the demand for investment (loans) Increase in budget deficit causes fall in investment • The govn’t borrows to finance its deficit, leaving less funds available for investment. • Crowding out private sector investment • Investment is important for long-run economic growth. o Budget deficits reduce the economy’s growth rate and future standard of living. • Lower interest rates à better economy Money -Without money, trade requires Barter • Barter: find someone who has what you want and wants what you have. • Requires a double coincidence of wants: two people each have a good the other wants • *Unnecessary with money, the set of assets that people regularly use to buy goods and services from other people. Three functions 1) A medium of exchange: an item buyers give to sellers when they want to purchase goods and services 2) Unit of account: the yardstick people use to post prices and record debts 3) Store of value: an item people can use to transfer purchasing power from the present to the future 2 Kinds of Money • Commodity Money: takes the form of a commodity with intrinsic value (e.g., gold coins) • Fiat Money: money without intrinsic value, used as money because of govn’t decree and faith in its acceptance (e.g., green pieces of paper) Money Supply: the quantity of money available in the economy • Currency: the paper bills and coins in the hands of the (non-bank) public • Demand deposits: balances in bank accounts that depositors can access on demand by writing a check (or swiping a card) • Money Supply = Currency + Demand Deposits Central Bank: 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 (Fed): the central bank of the U.S. • Not federal govn’t • Independent of politics Structure of Fed: • Board of Governors (7 members) in DC o Appointed by president and confirmed by senate (14 year terms) • Presidents of regional Fed Banks (12 located around U.S.) o Regional banks are independent entities under the BoG and self-sustained with annual “dues” • FOMC (Federal Open Market Committee): includes the board of Gov.s and presidents of some of the regional Fed banks. The FOMC decides monetary policy (one chair of FOMC) Banks… Fractional Reserve Banking System: commercial banks keep a fraction of deposits as reserves and use the rest to make loans. • The Fed est. reserve requirements: regulations on the minimum amount of reserves that banks must hold against deposits. • Banks may hold more than this minimum amount if they choose. • Reserve Requirement = 10% The Reserve Ratio, R = fraction of deposits that banks hold as reserves WEDNESDAY APRIL 13 Bank T Account (pic) (objects of value or claim)Assets Liabilities (someone has a claim on the bank) Reserves($20) Deposits ($100) Loans ($80) R = 20/100 = .2 (Money Supply) MS = Currency + Demand Deposits Assets Liabilities Reserves($.08) Deposit($.16) $.04 $.08 $.02 $.04 $.01 $.02 $.01 $.01 $.16 $.31 (~$.32 because of li)it Money Multiplier: the amount of money the banking system generates with each dollar of reserves. • The money multiplier equals 1/R • Last example: R = .5 o 1/R = 1/.5 = 2 o .16 * 1/R = .32 • Demand Deposits = Reserves * 1/R Ex: Suppose the US is completely destroyed in a war and all currency is destroyed (starting over). Assume the Fed prints $500 which the banks keep as reserves, people hold no currency and only use checks/cards. • A) If the reserve ratio is initially 50%, how large is the money supply? o $1,000 • B) As stability returns, banks loan out a larger fraction of deposits keeping only a 10% reserve, how much does the money supply expand over this period? o $5,000 (reserve) - $1,000 = $4,000 reserve expanse How does the Fed control the money supply? (4 Tools) 1) Open-Market Operations (OMOs): the purchase and sale of U.S. govn’t bonds by the Fed. • To increase money supply, the Fed buys govn’t bonds, paying with new dollars. (HINT: Janet Yellen BUYS bonds) o …which are deposited in banks, increasing reserves o …which banks loan, causing MS to expand • To decrease money supply, the Fed sells govn’t bonds, reversing the process (and Janet Yellen SELLS bonds) • OMOs are easy to buy/sell o Fed’s monetary policy tool of choice 2) Fed Pays Interest on Excess Reserves: affects banks desire to make loans influencing money supply (pay off the banks to hold back from loaning) • To increase money supply, the Fed lowers interest paid on excess reserves. o Lower opportunity cost of making loans; more loans are made. • To decrease money supply, the Fed increases interest paid on excess reserves. Increases the opportunity cost of making loans; fewer loans are made. 4/20/16 10:34 PM MONDAY APRIL 18 Last week • How does the Fed control the money supply? (4 Tools) 1) Open-Market Operations (OMOs): the purchase and sale of U.S. govn’t bonds by the Fed. § To increase money supply, the Fed buys govn’t bonds, paying with new dollars. (HINT: Janet Yellen BUYS bonds) ú …which are deposited in banks, increasing reserves ú …which banks loan, causing MS to expand § To decrease money supply, the Fed sells govn’t bonds, reversing the process (and Janet Yellen SELLS bonds) § OMOs are easy to buy/sell § Fed’s monetary policy tool of choice 2) Fed Pays Interest on Excess Reserves: affects banks desire to make loans influencing money supply (pay off the banks to hold back from loaning) § To increase money supply, the Fed lowers interest paid on excess reserves. § Lower opportunity cost of making loans; more loans are made. § To decrease money supply, the Fed increases interest paid on excess reserves. § Increases the opportunity cost of making loans; fewer loans are made. Now… 3) The Discount Rate (penalty for over-lending) • the interest rate on loans the Fed makes to banks o If a bank is short on reserves, can borrow from Fed § “Lender of Last Resort” o To increase money supply, Fed lowers discount rate, reducing penalty for not keeping enough reserves § …Banks make more loans, increasing the money supply o To decrease money supply, Fed can raise discount rate 4) Reserve Requirement (RR): may affect reserve ratio (~10%) • To increase money supply, Fed reduces RR. o More loans from each dollar of reserves, which increases money multiplier and money supply. • To reduce money supply, Fed increases RR. • Not effective at increasing money supply and is super disruptive when reducing money supply: RARELY used by Fed as it is very disruptive to the market economy. Ex: • ] A) R=.25; 1/R=1/25=4 • Reserves increase from $50 to $125 • Money Supply=Reserves * 1/R o 125*1/.25= 125*4= $500 • The MS grew from $200 to $500, by $300 B) Reserve Ratio falls to .1 (10%) • MS=Reserves * 1/R = $50*1/R= $50*10= $500 • MS grew from $200 to $500, by $300 If the Fed is increasing/decreasing the key interest rate… The Federal Funds Rate: • Banks can borrow reserves from banks with excess reserves o Interest rate on these loans is the Federal Funds Rate. • The FOMC uses OMOs to target the Federal Funds Rate • Interest rates are highly correlated, so changes in Fed Funds Rate lead to changes in other rates. **Note: • Discount Rate is the rate that Fed lends to banksàserves as a penalty to banks for falling low on reserves • Federal Funds Rate is the rate at which banks lend to each other o NOT the rate from the Fed; NOT the rate on federal govn’t loans Bank Vault -Required Reserves -Bonds, extra cash = Excess Reserves (loanable) • If Fed buys bonds, bonds decrease and cash increases Federal Funds Market Loans between banks 1. Supply 2. Supply shifts right 3. FF decreases (E 0rops) Nominal Variables are measured in monetary units. • Nominal wage = $10/hr Real Variables are measured in physical units or output • Relative prices • Real wage = 1 pizza / hr Monetary Neutrality: the proposition that changes in the money supply do not affect real variables • Doubling money supply causes all nominal prices to double; what happens to relative price? (nothing changes) • $10 = 40 Quarters (i.e., monetary neutrality) Velocity of Money Equation Velocity of Money: the rate at which money changes hands (www.wheresgeorge.com) • V- the velocity of money • P- Price level (price of goods) • Y-Output/Real GDP • P*Y-Nominal GDP/”total spending” • M- Money Supply • V=(P*Y)/M [Velocity Formula] Velocity is relatively stable. The Quantity Equation Rearranged V equation • M*V=P*Y • V and Y are relatively stable variables • M and P are directly correlated WEDNESDAY 4/20 GOLD STANDARD HW on APLIA TONIGHT APLIA under unemployment due tonight as well Quantity Equation –where the money supply determines inflation Qequation M*V=P*Y • V is relatively stable o Plug in a constant (1) • %change in M * 1=%change(P*Y) • Y is RGDP o Y=Af(L,K,H,N) § No M, No P à Y is not dependent upon prices and money supply • Recall: %changeM*1= %change(P*Y) o V and Y are both relatively constant o Because %changeM doesn’t affect Y… Y=1 § %changeM*1 = %change(P*1) § %changeM=%changeP • Rapidly increasing the M (money supply), rapidly increases P(prices) o Money supply dictates inflation levels Vequation V=(P*Y)/M V is relatively stable The inflation fallacy: most people think inflation erodes real incomes. • Inflation is a general increase in prices of the things people buy and sell (labor) • In the long run real incomes are determined by real variables, not the inflation rate. The costs of inflation • Changing prices requires adjustments o Menus reprinted o Difficult to compare across time o Budget forecast inaccurate (very difficult)… The inflation Tax • Government spending funded by: o Taxes o Borrowing o Printing Money § Not US Gov., Fed handles MS • Almost all hyperinflations start this way • Referred to as the inflation tax: printing money causes inflation, which is like a tax on everyone who holds money Unexpected Inflation, Wealth to Debtors Arbitrary redistribution of wealth: higher-than-expected inflation transfers purchasing power from creditors to debtors (lender to borrower) • Debtors repay debts with dollars that aren’t worth as much The cost of inflation: costs are quite high for economies experiencing hyperinflation, but the costs with low inflation (<10%/yr) are probably much smaller *** Important that Central Bank be independent of politics Aggregate Supply and Aggregate Demand -short-run economic fluctuations are often called business cycles -Most economists believe classical theory- monetary neutrality- describes the world in the long run, but not the short run • In the short run, changes in nominal variables (like the money supply or P) can affect real variables (like Y or the u-rate) Model of Agg.Demand and Agg.Supply Long-run Agg.Supply (Y =An(L,K,H,N)) SRAS (short-run agg.supply) ADcurve: the quantity of all goods and services demanded at any given price level. AD=C+I+G+NX Assume G is fixed by govn’t policy Slope of AD: the Wealth Effect • Suppose price level increases • Real value o money falls • Consumers are poorer, purchase less (C) The Interest Rate Effect • Increased price level requires more liquid money (dollars) • Less saved, interest rate increased • Encourages less investment (declines) Exchange Rate Effect Why the Agg.Demand curve might shift • Changes in C o Stock market boom/crash o Tax hikes/cuts • Changes in I o Expectations, optimism/pessimism o Interest rates, monetary policy • Changes in G o Wars o Stimulus spending on new roads (“Fiscal Policy”) • Changes in NX o Booms/recessions in countries that buy our exports 4/20/16 10:34 PM 4/20/16 10:34 PM
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