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UCD / ECN / ECN 001 / Define capitalism.

Define capitalism.

Define capitalism.


School: University of California - Davis
Department: ECN
Course: Principles of Macroeconomics
Professor: N caramp
Term: Winter 2018
Tags: Macroeconomics, Money, demand, Interest, and bonds
Cost: 50
Name: Study Guide: Midterm 1 ECN 1B
Description: This study guide covers chapters 1-4 and some information included in the introduction to the class. Visuals were created by me. Chapter 5 has not yet been covered.
Uploaded: 01/29/2018
8 Pages 191 Views 2 Unlocks

ECN 1B: Principles of Macroeconomics created by Kelsey Kim

Define capitalism.

Midterm 1: Study Guide 

Chapters Introduction, 1-4


Definition: ​Economics is the social science that studies the choices that individuals, businesses, governments make regarding allocating resources in response to SCARCITY​.

- Choices are influenced by incentives​: a reward that encourages an action or a penalty that discourages actions.

Why economists care about inflation?


- Aggregate Demand

- Aggregate Supply

- Price Level, Inflation, GDP Growth - Unemployment, Inequality


- Market of apples/oranges

- Demand for apples/oranges

- Supply for apples/oranges

- Price of apples/oranges

Image: Depicts the circular flow

It is the rate at which inflation occurs, what is it?

Don't forget about the age old question of Which microorganisms can fix atmospheric n2 & change it into a form that is possible for other organisms to use?

ECN 1B: Principles of Macroeconomics created by Kelsey Kim

Capitalism-​ ​an economic system where the main institutions are private property, markets, ad firms If you want to learn more check out When did studying the consumer become important?

● Institutions- ​Laws and social customs governing the production and distribution of goods and services

○ Private Property- ​ownership rights over property; an important type is capital Goods​ *The biggest difference between communism/capitalism Don't forget about the age old question of Identify two founders of anthropology.

○ Markets- ​A way for people to exchange products and services for their mutual benefit (Reciprocated transfers, voluntary, competition encourages innovation and higher quality) * “quid pro quo”, ​an exchange

○ Firms- ​business organizations that use inputs to produce outputs

Positive Statement- ​A statement that can be tested against facts.

Normative Statement-​ An expression of opinion, cannot be tested against facts * Know these terms to be able to understand the context of questions

ECN 1B: Principles of Macroeconomics created by Kelsey Kim Don't forget about the age old question of What is the third planet from the sun?
Don't forget about the age old question of Who is fritz zernike?

Chapter 1: A Tour of the World 

(1.1) The Crisis: 

● From 2000-207, the world had sustained economic growth.

● 2007, U.S. housing prices declined which led to financial crisis (led to a fall in stock prices), U.S. output turned negative.

● Demand and consumption decreased.

● Many mortgages were given out for homes, banks then sold them to third parties to make $$ quickly. The financial crisis (stock market crash) correlated with the economic crisis, but did not cause it.

● Became world crisis through financial channels (like trade)

○ Emerging economies were uniquely not affected as much by this event.

(1.2) The United States 

Standard of Living- ​Quality of life, GDP is one way of estimating this. We also discuss several other topics like What inspired le sun to dig a cave-temple in dunhuang, china?

Output Growth- ​Range of change of output

Federal Funds Rate- ​The interest rate on federal bonds. *Decreased during 2007 crisis in order to incentivise people to sell bonds, hold money, and stimulate the economy. - Zero Lower Bound: ​If the interest rate was negative, there would be no incentive to hold bonds

Productivity Growth- ​Important for sustained increase in income per person.

(1.3) The Euro Area 

European Union (est. 1956)- ​Group of 28 countries that share a common market, goods move freely over borders.

Euro Area- ​Formed a common currency​ (1999)

Issues EA Faces:

- Reducing high unemployment rates

- Determining how to function efficiently within the EU when different countries have different economic problems.

(1.4) China 

PPP (Purchasing Power Parity)-​ Considering how if the value of the same goods in one economy differ from that in another, the same amount of money can buy different amounts of goods.


GDP- $17.4 Trillion

Per Capita- $54,000

- Accounts for 23% of world output *that’s


Euro Area 

GDP- $13.4 Trillion

Per Capita- $40,143

- Combined output of

many countries

compared to just 1


GDP- $10.4 Trillion

Per Capita- $7,627 ​($12,100 considering PPP)

- Fastest growing!

ECN 1B: Principles of Macroeconomics created by Kelsey Kim

Chapter 2: A Tour of the Book 

(2-1) Aggregate Output 

- Meaning “total”

Macroeconomics: ​the study of aggregate economic demand

● National Income and Products Accounts​ were developed at the end of WWII as measures of aggregate output

Measure of aggregate output is Gross Domestic Product (GDP)

3 Ways to Calculate GDP: 

1. GDP is VALUE OF FINAL GOODs AND SERVICES produced in the economy during a given period. 

a. Final Goods, not Intermediate goods

2. GDP is the sum of VALUE ADDED in the economy during a given period a. Value added = the value of production minus the value of intermediate goods used in the process.

3. GDP is the SUM OF INCOMES in the economy during a given period of time a. Labor Income- wages

b. Capital Income- value added (minus) wages

NOMINAL GDP- ​The sum of quantities of final goods produced, times their price Increases for two reasons:

● Production of most goods increases

● Price of most goods increases

REAL GDP-​ The sum of the quantities of final goods, times constant (not current) prices 2009: Real GDP = Nominal GDP​ often used as a good base year for constant prices.

(2-2) The Unemployment Rate 

Labor Force (L) = Employment (N) + Unemployment (U)

UNEMPLOYMENT RATE- ​ratio of the number of people who are unemployed in the labor force unemployment

u = LU = labor force 

Current Population Survey (CPS)-

Discourage Workers- ​People no longer looking for jobs, excluded from the labor force and unemployment

Participation Rate- ​ratio of labor

(2-3) Inflation Rate

ECN 1B: Principles of Macroeconomics created by Kelsey Kim

INFLATION- ​ a sustained rise in the general levels of prices

INFLATION RATE- ​the rate at which inflation occurs

DEFLATION- ​sustained decline in price levels

GDP DEFLATOR-​ ​the ratio of nominal GDP to real GDP in year t

Pt = (Nominal GDP/Real GDP) = ($Yt/Yt) 

Rate of Inflation (% Change) = ​(Pt-Pt-1)/Pt-1 

The Consumer Price Index (CPI): ​The thing used to measure the cost of living What is it? ​A compiled list of specific goods and services (basket), average quantities consumed in a year, and cost in dollars

*​ It’s also another way to measure inflation

Why Economists Care About Inflation:

● Pure Inflation: ​when a % increase of inflation translates to the same increase of wages (real wage) This doesn’t exist!

● Inflation affects income distribution when not all wages rise proportionally ● Some prices and taxes are fixed, thus, costs are distorted during inflation ● Best inflation rate is between 1-4% (FED target is 2%)

● Taxes also do not adjust well to

Chapter 3: The Goods Market 

Short Run: ​(1-2 years) Movements in demand, unemployment, capital

Medium Run: ​(2-10 years) Economy returns to the conditions determined by fixed supply factors (capital stock, level of technology, size of labor force).

Long Run: ​(10+ years) Evolution in supply factors (Capital, Stock, Technology, human capital)

Year to Year Movements in Economic Activity:

Δ ​in demand for goods ⇨ Δ ​in production ⇨ Δ ​in income ⇨ Δ ​in demand for goods (etc.) (3-1) The Composition of GDP 

CONSUMPTION (C) -​ ​goods and services purchased by consumers (the largest component!) INVESTMENT (I) - ​of fixed investment - the sum of non-residential investment and residential investment. Note: Buying a house is under the category of investment, not consumption. GOVERNMENT SPENDING (G) -​ ​purchases of goods and services by the federal, state, and local governments excluding Government Transfers - i​ ndirect consumption. Expenses incurred by the gov’t, but consumed​ by the people.

EXPORTS (X) -​ ​Purchases of goods and services by foreigners

IMPORTS (IM) -​ ​Purchases of foreign goods and services by U.S. consumers NET EXPORTS/TRADE BALANCE: (X-IM)

ECN 1B: Principles of Macroeconomics created by Kelsey Kim

Exports > Imports = Trade Surplus

Imports >Exports = Trade Deficit

INVENTORY INVESTMENT - ​The difference between production and sales (inventory positive if production exceeds sales). Things produced, but not sold.

Y = C + I + G + (IM-X) (equation for GDP)

(3-2) The Demands For Goods 

The total demand for goods (Z) can also be called ​Aggregate Demand (Z) is also the sum of consumption

Z ≡ C + I + G + (X − IM)

In a “CLOSED ECONOMY”​ X = IM = 0 or assumer there is no trade.

So that the equation for demand in this model is...

Z ≡ C + I + G 

Consumption Function: ​depends on disposable income, YDis a linear function C = C(YD)

C = C0+ C1YD 

C = C0 + C1(Y-T) 



● Co, Consumption level at $0 (can be due to savings, borrowing from people) ● C1, Propensity to Consume​, a.k.a. Marginal Propensity to Consume; 0<C1<1 ○ Slope of function

○ (1-C1) is the Propensity to Save

● YDis defined as (Y-T)

ENDOGENOUS- ​Variable explained within a model (think of it as a dependent variable) EXOGENOUS- ​Given information, variables not affected by the model (think of it as independent variables)

Fiscal Policy- ​Choices of taxes and spending by the government described by T and G

(3-3) The Determination of Equilibrium Output 

Z ≡ C + I + G

Z = (C0 + C1(Y-T)) + I + G

Equilibrium in the Goods Market- ​requires production, Y, to be equal to demand for goods Z, Y=Z, I is fixed (“I-bar”) ​*​Watch videos posted on canvas from week 2, they explain graphs! Z ≡ C + I + G

Z= (C0 + C1(Y-T)) + I + G

If Y=Z (in equilibrium), then

Y =​ (1/1-C​1​)​[C​0​ + I + G - C​1​T]

ECN 1B: Principles of Macroeconomics created by Kelsey Kim

The Multiplier, Autonomous Spending 

● The MULTIPLIER:​ is a number greater than 1 because 0<C​1​<1. ​Any changes made to autonomous spending will be amplified by the multiplier.

● AUTONOMOUS SPENDING: ​Spending that doesn’t depend on output.

Geometric Series ​*​View Figure 3-3 in book

An increase in demand will lead to and increase in production

An increase in production will lead to an increase in income

An increase in income will lead to an increase in demand

And so forth… until equilibrium between Income and Demand/Production is equal. *Understand that this concept explains how a change in one factor is followed by other changes that result in a new point of equilibrium.

Chapter 4: Financial Markets 

(4-1) The Demand for Money 

“Money”​ are used for transactions, but it pays no interest.

- Currency:​ coins and bills

- Checkable Deposits: ​checks, debit cards

“Bonds”​ pay positive interest rates, but cannot be used for transactions How much of bonds or money should a person hold?

- Level of transactions; How much money do you need?

- The interest rate of bond; How much money could you be making from holding bonds?

Semantic Traps! Money, Income, Wealth (p.69 in book) 

Money- ​is what can be used to pay for transactions

Income- ​is what you earn

Saving Rate-​ the fraction of disposable income (income after taxes paid) that is saved Savings- ​is what you have accumulated over time

Financial Wealth-​ or wealth, is the value of financial assets minus financial responsibilities

Investment- ​the purchase of new capital goods

Financial Investment- ​is the purchase of shares or other financial assets

DEMAND FOR MONEY (M​d​):​ Roughly proportional to nominal income ($Y) times a decreasing function of the interest rate i. The interest rate has a negative (-) effect on Md. An increase in income would shift the Md curve to the right because having more income, means wanting more money to spend in the economy.

M​d​= $Y x L(i) 


ECN 1B: Principles of Macroeconomics created by Kelsey Kim

(4-2) Determining Interest Rates I 

In EQUILIBRIUM, Money Supply (M​s​) should equal Money Demand (M​d​).​ In the model, if we assume all money is supplied by the government, money supply, is equal to the amount the government decides to supply (M).



(4-3) Determining Interest Rates II 

Monetary Policy and Open Market Operations: ​Central banks typically change the supply of money buy buying or selling bonds through in the bond market

Assets of the Central Bank: ​The bonds it holds

Liabilities of the Central Bank: ​The stock and money in the economy

EXPANSIONARY​ open market operations: - FED buys bonds

- DEMAND for bank increases

- Interest rate decreases, $PBincreases - More incentive to sell bonds and hold cash

- MsIncreases



- FED sells bonds

- Interest rate increases, $PB decreases - More incentive to hold bonds and make money from interest

- Ms Decreases

Determining the Interest Rate: ​Suppose a bond such as a Treasury Bill promises to pay $100 1 year from now. If the price of the bond today is $PB, then i on the bond is: $100−$Pb 

i = $Pb 


Determining the Price of Bonds: $PB = 1+i 

Note: ​Rather than money supply, the central bank typically chooses an interest rate, and adjusts the Ms 

Reminder: ​In reality, not all the money in the economy is supplied by the Central Bank. Money also includes currency and checkable deposits provided by private banks. - Banks are a type of Financial Intermediary​- institutions that receive funds to buy financial assets or to make loans to other people

(4-4) The Liquidity Trap: ​The Government can choose the interest rate it wants on bonds. IMPORTANT CAVEAT: The interest rate cannot go below the zero lower bound. - When i reaches zero, monetary policy cannot decrease it further.

- Liquidity Trap! ​In a crisis, the government has no capacity to stimulate the economy once the interest rate reaches zero.

- On a graph, the demand for money becomes horizontal at i=0. Further changes to Ms will have no effect on i.

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