ECON 202 Midterm 2 Review
ECON 202 Midterm 2 Review Econ 202
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This 15 page Study Guide was uploaded by Ava Jamerson on Sunday November 8, 2015. The Study Guide belongs to Econ 202 at University of Oregon taught by Urbancic M in Summer 2015. Since its upload, it has received 38 views. For similar materials see macroeconomics in Economcs at University of Oregon.
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Date Created: 11/08/15
Midterm 2 ECON 202 Chapter 8 How is Inflation Measured? The Consumer Price Index (CPI) consumer price indexmeasure of the price level based on consumption patterns of average consumer can be seen as "basket of goods" ex. groceries, medical care, clothing, computing the CPI o compares cost current period of basket in base period to the cost in the base period of that same basket of goods o simple price index: compare (1st sum/1st sum) x 100 to (2nd sum/1st sum) x 100 o final step: create index equal to 100 at a fixed point (base year) o prince index = (basket price/basket price in base year) x 100 measuring inflation rates o after CPI, then measure inflation rates from period 1 to 2, annually o inflation rate (i)=[(p2p1)/p1] x 100 o ex. CPI rose from 100 to 125, inflation was 25 because (125100/100) x 100 is 25% o 19602012 typical basket rose sevenfold economics in the real world o prices don't move together, ex. technology prices fall drastically o computers 1984 apple sold for 2495, now the newest model less than 2000 using the CPI to equate dollar values over time o to compare prices in today's dollars, theres a formula o price in today's dollars = price in earlier time x (price level today/price level in earlier time) o ex. 2012 price 1924 house, CPI in 2012 was 230, in 1924 it was 17 o so price in 2012=$1969 x (230/17)=$26,639 The Accuracy of CPI o other than helping us understand economics, employers use the CPI to adjust wages for inflati,if CPI understates inflation, workers will get hurt o typical basket changes so much, makes it hard to measure price o most common worryinflation will be overstated o three reasons for concern: substitution, quality change, and availability o substitution quality gets higher ex. movies, increase seems like inflation, but really also higher quality to prevent this CPI has adjustment method o new products and locations in growing economy new goods are introduced ex. flash drives, amazon.com BLS used to only update after a long time, which caused upward bias if BLS only checked traditional stores, they would overstate prices to solve this, they used chained CPI where the goods are updated monthly gives lower inflation measurement o economics in the real world billion prices project at MITT monitors daily price fluctuations of 5 billion items by 300 online retailers in 70+ countries only tracks online and doesn't weight them, but still close to CPI able to point out meaningful trends earlier What Problems Does Inflation Bring? inflation is not harmless either, it imposes many costs shoeleather costs o in order to avoid "tax" on holding money, people hold less many, more visits to bank o shoeleather costs resources that are wasted when people change their behavior to avoid holding money money illusion o people don't react rationally to inflation o they think things are more expensive when really their salaries also increased o as a result, they change habits ex. not going to see movies as often o money illusion when people interpret nominal changes in wages as real changes o key distinction is between real wages and nominal wages o nominal wage a person's wage expressed in current dollars o real wage nominal wage adjusted for changes in the price level (more informative) menu costs o physically changing prices is costly o menu costs are costs of changing prices o some businesses can do it easily, others can't ex. restaurants and new menus o another costlosing customers because they're angry uncertainty about future price levels o ex. to start business you must first invest, same with GDP o we must invest in today to increase GDP in the future o firm sells output or the production a firm creates at the end o wage and loan contracts form foundation of production, high risk, so inflation can lower economic output wealth redistribution o you borrow $500,000 and will pay back $600,000 in 5 years o inflation makes you paying it back benefit you but screws the bank o crates risk on making loansvery important source for business ventures price confusion o market prices signal consumers and firms o ex. if demand increases, firm produces more o but dangerous because it may be due to inflation ex. housing bubble tax distortions o even if all prices raised together, still distortions b/c tax laws don't account for inflation o ex. capital gains taxestaxes on gains realized by selling asset for more than purchase price o ex. house you sell for more than you bought, and the gain is taxed o however the CPI makes the price you sold it for the same as when you started o as a result you were taxed on a gain that wasn't as much as it could have been o also applies to stocks, bonds etc. What is the Cause of Inflation? most inflation rates and money supply growth rates across 160 countries are onetoone however countries like Brazil and Angola with incredibly high rates o the reasons governments inflate the money supply debts cause governments to print more money ex. Germany inflation rate 30,000% stimulate an economy toward more rapid growth rates ex. China Chapter 9 What is the Loanable Funds Market? financial marketwhere firms and governments obtain funds or financing (primarily household) loanable funds marketwhere savers supply funds for loans to borrowers no physical location ex. investment banks, mutual fund firms, commercial bank demanders of funds are firms and governments firms must borrow today to generate future GDP, save to sustain future production advantage of this demand and supply is that it clarifies role of interest rates interest rateprice of loanable funds two different views of interest rates: view of saver and view of borrower interest rates as a reward for saving o interest rate is return a saver gets for supplying funds o the higher the interest rate, the greater the reward, greater incentive o interest rateopportunity cost of consumption interest rates as a cost of borrowing o borrowersinterest rate is the cost of borrowing o firms borrow only if they can pay back the money and interest o the lower the interest, better chance firm can pay you back o lower interest=greater demand for loanable funds (demand=investment is negative) how inflation affects interest rates o inflation affects interest you receive o when deciding about saving and borrowing, people look at real interest rate o real interest rateinterest rate corrected for inflation o nominal interest rateinterest rate before inflation correction o Fisher equation= nominal interest rateinflation rate o higher inflation= higher nominal rates to compensate lenders for the loss of purchasing power o nominal interest rate = real interest rate + inflation rate o usually we look at nominal interest rates because they are stated in interest rates steady inflation means the difference between real and nominal is small What Factors Shift the Supply of Loanable Funds? three factors that determine level of supply curve o income & wealth as nation gains wealth, more savings foreign savings are in US loanable funds market o time preferences time preference people would rather receive funds sooner than later strong time preferencewant to receive funds sooner, vice versa with weak time preference people with strong time preference save less ex. person not going to college because they want to earn income in that time when time preference increases, rate of savings (personal savings as a portion of disposable) goes down o consumption smoothing in lifetimeincome varies drastically income levels low when young, highest in middle, low at the end borrowing, saving, dissaving (withdraw funds from previous accumulated savings) by doing that^ we smooth out income and consumption, creating a normal consumption patterconsumption smoothing if stable amount of people moving into each life stagesavings is stable problem: baby boomers, causing record retirement, less saving What Factors Shift the Demand for Loanable Funds? productivity of capital o ex. firm deciding whether to invest in machine (capital) o they have to determine if return is greater than interest rate o capital=productive, demand for loans increases vice versa investor confidence o demand depends on beliefs or expectations of investors o if it believes sales will increase, it invests more today o investor confidencemeasure of what firms expect of future economic activity interest rate only leads to movement along the demand curve, no shift in loanable funds How Do We Apply the Loanable Funds Market Model? equilibrium o occurs where plans of saver=plans of borrowers, or supply=demand o savings=investment o investment requires saving because every dollar borrowed requires a dollar saved o account for changes in market functions by using shifts in supply and demand o decline in investor confidence when economy lows, firms reduce investment due to low expectations for sales ex. great recession 2007 lower investor confidence=lower interest rates=lower equilibrium level of investment o a decrease in the supply of loanable funds baby boomers leads to decrease in supply of loanable funds=lower investment=lower GDP but other factors may change this ex. foreign investment Chapter 10 How do the financial markets make money? institutional viewconsider what types of firms operate and what tools they use major playerfinancial intermediaryfirms that channel funds from savers to borrowers ex. bankprivate firm that accepts deposits and extend loans direct and indirect financing o 2 paths through loanable funds: indirect and direct finance o indirect financesavers end funds to intermediaries, then loaned to borrowers o direct financeborrowers go directly to savers for funds o direct finance needs contractsecurity tradable contract that entitles owners to rights o ex. bond security that represents debt that should be paid (IOU) importance of financial markets o macroeconomic growth based on GDP, which comes from individual firms o the firms get funding from financial markets economics in the real world: why bail out the big banks? o Lehman Brothers went bankrupt for U.S. government used TARP to give $700 billion to banks o didn't seem right, BUT it prevents output from halting What Are the Key Financial Tools for the Macroeconomy? bonds o contract contains: name of borrower, repayment date, and amount due o date when payment is due is maturity date o face value/par value represents the value of the bond at maturity (amount due) o initial loan amount not included, but usually round number o many bonds include coupons for periodic interest payments o interest rate = r = (face value initial price)/initial price = (pm po)/po interest rate is computed as growth rate as price of bond drops, interest rate rises, inverse relationship o default risk two outcomesborrower pays, or defaults on the loan default risk risk that borrower will not pay the face value at the date greater the risklower the price of bond bond price principle: bond interest rates rise with default risk o bond ratings three agencies for evaluating riskMoody's, Standard and Poor's, and Fitch AAA is best, to CCC, and D BB and lower are noninvestment grade, or junk bond stocks o another option, stock is ownership shares in a firm o bad thing: giving up ownership o shareholders can determine direction of company secondary markets o people who buy stocks and bonds go through brokers o brokers buy them in secondary marketssecurities are traded after first sale o used security is ok, from places like NASDAQ and NYSE o second market increases demand for that security, causing price raise economics in the real world: DOW vs. S&P o when stock index rises or falls, indicates corresponding rise and fall in stock prices o Dow Jones Industrial Average tracks 30 companies o editors on Wall Street maintain index, companies are averaged o S&P 500 index weighs stock by market value o # of stock multiplied with price per share, tracks 500 companies treasury securities o US Treasury has debt by using bonds o treasury securities are bonds sold by government to pay debt o considered less risky, but not true if there was global financial turmoil o $4.5 trillion held by foreigners o they keep interest low, promoting more investment and greater GDP o the longer it takes, the higher the interest rate is home mortgages o most common 30 years, 360 monthly payments o home mortgage market has expanded from 2.2 trillion to 10 trillion securitization o secondary markets reduce borrowing costs, incentives to create new markets o secondary markets for home and student loans o made possible by being securitizedcreation of new security by combining otherwise separate loan agreements o not only does it lower interest rates, also offers new opportunities to lenders Chapter 11 Why Does Economic Growth Matter? economic growth means wealthier societies and higher standards of living indicators such as o infant mortality rate and lifespan o rich nations have more doctors and cleaner water o nonessential items ex. cars, computers, internet o education, literacy (gender plays role) Angus Maddison measured world's nations GDP in 1 A.D. o historical break in 1800s o industrial revolutioncenter of economic breakthrough o it encourage privateproperty protection and technological advancements wealth is not evenly distributed o 1900 some countries broke out of poverty ex. U.S, Europe o 2000 the gap increased o some have became rich in the past decades. ex. South Korea measuring economic growth o small increases in growth rate become significant o economic GDP growth = % ∆in nominal GDP% ∆price level% ∆population o rule 70if annual growth rate s x%, then the seize variable doubles every 70/x years How Do Resources and Technology Contribute to Economic Growth? significant consensus of the three parts of economic growth, reasouces, technology and institutions Resourcesfactors of production are input o natural resources ex. physical land or what occurs on/in the land geographic location, are you loose to someone disease? they help, but not as they good as having economic development ex Hong Kong o physical capital tools and equipments used for production shipping container fast ad efficient as physical capital per workers increases, so does total output large capital projects only work well if they mesh with economy o human capital human capitalresource represented by the quantity, knowledge and skills of workers in a community more output does not = more economic growth b/c GDP per capita possible to increase through education and training ex. where education did not helpIndia o technology technologyknowledge that is available for use in production technological advancementintroduces new techniques or methods so firms produce more valuable outputs per unit of input ex. Henry Ford assembly line What Institutions Foster Economic Growth? institutionsignificant practice, relationship or organization in a society ex. laws, social and work habits not tangible we will look at most significant institutions that affect production private property, rights, political stability and rule of law, open and competitive markets, efficient taxes, stable money and prices private property rights o means individuals can own property and use it in production and owning resulting output o ex. Liberia has no dependable market for property while Taiwan does o China let loose in 1980s through Deng Xiao Ping, unexpected growth political stability and rule of law o ex. Liberia had 35 years of civil unrest, no company wants to invest in a dangerous country o disincentive for investment o ex. corruption is common and dangerous to growth, less private investment competitive markets & open markets o competitive markets consumers buy goods and lowest price inhibits competition and innovation monopolies prevent competition and therefore growth o international trade specialization makes all countries better off output increases when nations trade for goods they need o flows and funds across borders opportunities for investment expand if there is access to savings around the globe foreigners can put money in economy restrictions are found in developing countries, forcing firms to find domestic savers efficient taxes o taxes provide revenue for government services o do not tax activities that promote growth o if we tax income, we tax output and GDP o before, nations depended on taxes on imports, but that impedes growth as well stable money and prices o inflation will reduce investment, and therefore growth o in the U.S. FED controls monetary policy, which leads to highly variable inflation rates
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