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ECON 202 Midterm 2 Review

by: Ava Jamerson

ECON 202 Midterm 2 Review Econ 202

Marketplace > University of Oregon > Economcs > Econ 202 > ECON 202 Midterm 2 Review
Ava Jamerson
GPA 3.85

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Urbancic M
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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,  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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