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Midterm Two Study Guide

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by: Maddie Evans

Midterm Two Study Guide EC202

Marketplace > University of Oregon > Economcs > EC202 > Midterm Two Study Guide
Maddie Evans
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Hey everyone, it's time for midterms again! Here are my notes from Macroeconomics with Urbancic... my notes include the lecture notes from class, real life examples, and additional textbook informa...
Dr. Urbancic
Study Guide
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This 7 page Study Guide was uploaded by Maddie Evans on Thursday November 5, 2015. The Study Guide belongs to EC202 at University of Oregon taught by Dr. Urbancic in Summer 2015. Since its upload, it has received 153 views. For similar materials see Macroeconomics in Economcs at University of Oregon.


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Date Created: 11/05/15
Macroeconomics Exam 2 Study Guide Inflation  Inflation – an increase in the overall price level (price of item changing/increasing)  Hyperinflation – Time of rapid increases in overall price level at 50% per month  Disinflation – decrease in the rate of inflation  Deflation – decrease in the overall price level Price Index and CPI  Price Index – used to measure the overall price levels  GDP Price Index – Price index that pertains to all goods and services in the economy o No double-counting  Consumer Price Index (CPI) – price index created each month by Bureau of Labor Statistics that makes a “market basket” purchased monthly by an average consumer o Market Basket average rates  Housing – 41%  Transportation – 17%  Food and Beverage – 15%  Medical Care – 7%  Recreation – 6%  Communication – 4%  Apparel – 4%  Education – 3%  Other – 3% o CPI is surveyed and computed each month by:  8,000+ goods and services  211 categories  38 geographic locations  Determine how each goods impact a consumer budget  Must be exact same items each month at same quantities o Find a Price Index using CPI with equation:  Price index in year y = basket price in year y/ basket price in base year x 100  Once price index is found for certain years, can find inflation using percentage change formula o Inflation rate = CPI 2 ndyear – CPI 1 year/ CPI 1 year x 100  Calculate Real GDP to find out how many goods and services have been produced in a year in relation to another year  Calculate inflation to see how much prices change in relation to different years  CPI often overstates inflation because: o Consumers usually substitute in cheaper alternatives to items that have undergone inflation (chicken instead of steak) – substitution bias o New goods show up and prices are lower in first few years as well as cheaper buying options o Doesn’t adjust for increase in quality  Macbook Air will cost less than an original Macintosh but is undeniably better o BLS tries to measure using chained CPI that attempts to fix the problems related to over-inflation (listed above)  Moderate and expected inflation can be accounted for and prepared for with proper precautions o Families can plan expenses and savings according to inflation and what will be the new price index o Companies can determine future costs and wages and plan accordingly o Workers would be able to argue for better wages in preparation for inflation  Unexpected inflation can cause major problems for families, firms, and government  Chained CPI measures the CPI on a monthly basis  Billion Prices Project - a daily monitor that checks fluctuations of over 5 million items sold on 300 online retailers in 70 countries Terms at a Glance (more below)  Shoeleather Costs – When time and resources are spend to guard against effects of inflation  Money Illusion – Consumers misinterpreting nominal changes as real changes  Menu Costs – Needing to incur extra costs to change prices (restaurants printing new menus each time prices change)  Wealth Redistribution – Surprise inflation redistributes wealth between borrowers and lenders  Price Confusion – Inflation making it difficult to read price signals and confusion to lead to misallocation of goods and resources  Tax Distortions – Inflation making capital gains appear larger and increasing tax burdens Shoeleather Costs  Inflation making more expensive to hold cash and not put it in interest-bearing account  Time and resources wasted when people are forced to change behavior in a response to inflation o Driving to ATMs more often to receive cash o Shopping immediately after receiving paycheck Money Illusion  Workers not often paying enough attention to real wages (how much money can buy) but rather the nominal wages (dollar amount given)  Inflation makes it more confusing as people try to optimize purchases and behavior  May find that movie tickets are more expensive but not realize wages increased as well Menu Costs  Businesses often have to change their menu prices to adjust to inflation which costs money, causing many companies to make their menus electronic or chalkboard Costs of Inflation  Everyone has to attempt to plan ahead in savings to account for inflation  Unexpectedly high inflation makes it hard to plan, especially long-term for businesses and has many questions unanswered, like: o How many supplies to purchase? o How many employees to hire? o How many supplies are needed?  Inflation changes the distribution of income, hurting those who are stuck in a fixed income  Those who live on social security fare well since their benefits are indexed to inflation, so their rates rise equally to that of inflation  Welfare benefits are not indexed  Inflation that is higher than expected is better for debtors since what they have to pay back will not be worth as much later on  Inflation that is lower is better for creditors since what they will receive will be higher than when the loan was given  Price confusion often causes mistakes for households and individuals don’t know what to do about price changes  Taxes on capital gains (selling a house for more than was purchased) does not take inflation into account, making real estate a very lucrative market  Many countries’ leaders focus their incentives on stopping inflation o Severe recessions came along with high unemployment in order to minimize inflation in the 1970’s and 1980’s Investments and Financial Markets  Investment decisions are primarily made by firms  Financial markets exist to direct savings into profitable investment projects  Households decide how much to save and firms are able to undertake portion of investment  Loanable Funds Market the market where savers supply loans for borrowers  Savings rate is personal saving as a portion of disposable (after- tax) income  Expanding existing firms and creating new firms requires capital that comes from savers Present Value  Present Discounted Value (PDV) or Present Value (PV) of an amount F dollars to be paid t years in the future is the amount you need to pay today, at current interest rate (r) to ensure that you end up with f dollars t years from now  PV is current market value of f dollars in t years  PV = F/ (1+r)^t  Investments should be undertaken if the expected earnings from the investment exceed the price of the investment to undertake now Expected Rate of Return  Expected rate of return is the annual rate of return through a capital investment by a firm, but depends on: o Price of investment o Length of time the project provides additional costs or savings o Expected amount of revenue for each year Interest Rates  Demand for loanable funds to purchase new capital depends on interest rates  When interest rate is low, firms more likely to invest  Interest rates determine the direct cost or opportunity cost for each project  Interest rate an equilibrium price of money in market for loanable funds o Price to buy when looking for money from banks or institutions o Price to sell when saving money and giving to banks or institutions  Most homes save some income for future use, such as after retirement  Savings becomes more attractive when interest rates are higher, supplying more loanable funds  Interests rates are always quoted in nominal terms (current dollars)  Real interest rate is difference between nominal rate and inflation o Real Interest Rate = nominal interest rate – inflation rate  Capital Productivity creates more demand, increasing goods and services produced  Investor confidence increases demand and loanable funds  Income and wealth are a factor as those with more money can supply more loanable funds  The more patient a household is with consumption, the more it will save for the future and will benefit from inflation Fund Supply Factors  Consumption smoothing the idea that most individuals go through the following steps: o Borrow – financing education, houses, cars when young and without money o Saving – middle aged and able to save the excessive income o Dissaving – When income no longer coming in and removing money from savings  Firms borrow money to pay upfront costs when doing new investment projects  Indirect financing is how households borrow money – banks an intermediate between depositors and borrowers – accepting deposits and extending loans  Direct financing the ability to buy bonds in exchange for funds from institutions or households  Investor confidence is a measure of what firms expect for future economic activity Bonds  Bond - promise from government or firm to repay a loan with interest paid at intervals (interest sometimes called coupons)  Not money but can be purchased or sold for money  Bonds can last any length of time – the date a bond paid is called maturity  Face value of bond is amount that will be paid at maturity and is labeled on bond  Coupons are interest that is paid before reaching maturity  No matter what bond is traded or sold for, bond will always pay face value at maturity, as well as on stated coupons  Some bonds don’t pay coupons but discount from the face value  Interest rate of bonds: Interest rate = (face value-price)/price  Many pension funds are only interested in safe bonds where demand is higher  Higher-rated bonds are safe, have higher prices, and give lower interest rates  Longer-term bonds usually pay more interests  Yield curve is graph that shows the relationship between time and interest of bonds  Default risk is the risk that the borrower may not pay the face value that was agreed upon by the maturity date Stocks  Stocks are shares or partial ownership in a company  As the company profits and assets change, stock prices change, though your ownership percentage in the company stays the same  Stocks are almost always riskier than bonds  Usually have higher returns since there is less demand with lower prices  Stocks have an average of 6% higher return than bonds each year since 1880 Economic Growth  Economic growth the sustained expansion of real GDP over a given period (usually 3 month or annual cycle) – not temporary  Economic growth rate is the average annual percent change of real GDP, typically covered over multiple years  Real Per Capita GDP Growth = Nominal GDP Growth Rate – Inflation Rate – Population Growth Rate  US real per capita GDP has tripled between 1960 and 2010, while areas of east Asia have been even more lucrative  Exponential growth is when something is growing by a particular percentage each year for multiple years  Rule of 70: Number of years it takes for level of a variable to double is 70 divided by annual percentage growth rate of variable as a percentage o With 10% growth, 70/10 = 7 years to double the starting amount with 10%  1910-2010 growth in real per capita GDP has been 2% per year in the U.S. o Fell drastically during Great Depression and Second World War o Growth most rapid during 1960’s o Growth slowed during 1970’s and sped up again in 1980’s Economic Growth Sources  Factors of Production Increases: o Natural resources  Inputs used to make goods and services  Land  Coal in U.S.  Oil in Saudi Arabia  Geography and natural disasters affecting natural resources o Physical Capital  Capital  Factories, tools, equipment used in production  Infrastructure like roads, airports, computer networks o Human Capital  Labor is workers in economy  Effective labor  Time taken to train and educate employees  Better trained employee more valuable  Technology improvements o New technology (robots, machines) enhances labor productivity and allows for greater economic growth per capita  Better institutions


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