Final Study Guide
Final Study Guide EC 2113
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Date Created: 12/03/15
EC 2113 Principals of Macroeconomics with Dr Lozano Final exam Study Guide December 10 2015 Chapter 1 0 Economics The social science of determining the best use of scarce resources to achieve the maximum satisfaction of economic wants 0 Models Economic models are used to analyze situations to determine the best course of action often in graphical format Microeconomics Individual firmspeople Macroeconomics Total economy or an industry Positive Economics Factual statements Ex A rise in average temperatures will increase the demand for sunscreen productsquot 0 Normative Economics Statements that involve value judgements Ex Resources are best allocated by allowing the market mechanism to work freelyquot 0 Resources Four general resources Three have always existed while the fourth is relatively new I Land natural resources Ex minerals oil etc I Labor human work I Capital machinery I Entrepreneurship employs the other resources Involves innovation strategy risktaking Scarcity Basic Economising Problem trying to satisfy unlimited wants with limited resources Rational In economics individuals are assumed to be rational by default Meaning that an individual will only do something with the understanding that the benefit of doing so is greater than the cost 0 Opportunity Cost Everything has a price When there are multiple options to take with a limited number of options that you can take whatever you choose still has a price in the things that you did not choose What you have to give up in order to get something elsequot 0 In graphical analysis the opportunity cost can be found by determining the slope of the graph 0 Marginal Analysis 0 The basis for economic models Individuals make decisions progressively not all at once These decisions are made by the analysis of marginal cost versus marginal benefit I If the Marginal Cost of an actionchoice is greater than the Marginal Benefit a rational individual will not continue I If the Marginal Benefit is greater than or equal to the Marginal Cost a rational individual will agree to the action 0 Utility Happiness is used to measure whether a person will do something in economics the term utility is used as a way to measure happiness 0 Economic Principles 0 Graphical Analysis and Graphical Expression I Graphs are used to determine nearly every economic choice 0 Ceteris Paribus I Other things equalquot When analyzing a situation most economic models assume a freezeframequot of the situation This means that the model is accurate as long as a certain set of conditions is trueremains true 0 Production Possibilities Curve 0 Two axes are Consumer and Capital Goods The curve assumes full employment of resources a fixed amount of resources and a fixed level of technological advance Any change in these three factors results in a change in the curve O Constant Opportunity Cost Implies that resources used to produce capitalconsumer goods are perfectly exchangeable in use to produce the other Output of Go o d A EDD 160 ll 90 Output of39GDDd 13 Increasing Opportunity Cost Implies that the resources used to produce capitaconsumer goods are not perfectly exchangeable in use to produce the other 0 utput of Capital I22 I31 Output of Consumer Goods Economic Growth I Shown graphical by a shift in the curve economic growth can occur due to more resources better resources and improved technology This growth can occur simultaneously for both consumer and capital goods Production Possibilities Frontier i l l errMU p 392 Hanan Consumptions Goods I Or it can occur in a OneSectorquot fashion This occurs when the changes listed above only Motor vehicles Tl El Eh I 1 Food Eopyrigthl wwweonomic5wnlUnaGMG affect one of the types of goods 0 Unemployment and Unattainable Outputs 0 In the following model there are three points A B and C A represents a point in the Production Possibilities Curve that is attainable but does not use full employment of resources If full employment of resources were reached then the point B would be the current point at this point resources are being fully employed while still outputs are still attainable as the point lies along the curve Point C represents a desirable combination of resources but this point is not achievable under the current conditions as the curve would need to expand This point is unattainable within Butter 100 Production Possibility Frontier PPF I I I I GraphZ the current CeterIs ParIbus conditions 0 There are ways to reach point C It is possible to expand the curve with the economic growth factors It is also possible to achieve this point by international trade I Trade 0 International Trade can come in the form of countries specializing to produce products they are more readily disposed to create There are two key factors in the decision about what to specialize in Comparative and Absolute Advantage 0 Absolute Advantage If you can make more of something than another country you have absolute advantage in the production of that product 0 Comparative Advantage Actually used to determine who makes what This is an advantage of comparing opportunity costs 0 Example Problem If America can make 20 airplanes and 100 burgers at once and China can make 15 airplanes and 60 burgers at once who should make what ASSUME CONSTANT OPP COST I From the point of view of Absolute Advantage America should make both however that is not effective in the long run so Comparative advantage must be used Chapter 2 I America s opportunity cost in making Airplanes is 5 burgers for every 1 Airplane And V5 of a plane for every burger China s opp cost for making planes is 4 burgers for every plane and 1A of a plane for every burger Using these values you can see that 5 burgers is more than 4 burgers and 5 of a plane is less than 1A of a plane so America should specialize in Burgers while China should specialize in Planes I Weird example sorry had to make that one up 0 Economic Systems A set of instituted arrangements and coordinating mechanisms that decide on the production and exchange of goods as well as the use of resources 0 Differences misses Fame O v is Em m a 3mm mm p 1 mm m meha l a l i l mmg d Wmon Ef f m 39 No Gwemmm39 C t m f PW ifm mmg t QWW39W 1 s wtsm a Qam mmggm goeim Sm Differences Exist By I Degree of Decentralized use of market and prices in decision making I Degree of centralized government control 0 Market System 0 O O O A mix of decentralized decision making and some government control Found in much of the world Private markets dominate Incorporates I Private Property I Freedom of Enterprise and Choice you can choose to start a business and what you do with it I SelfInterest Everyone does what is best for themselves I Competition Only the best in a chosen industry stay I Market and Prices Supply and Demand determine price Technology and Capital Goods I Market Systems encourage advancement in technology Specialization I Market systems allow for specialization of labor or geographical specialization Money a medium of exchange that takes place of the the barter system Government might be needed to fixalleviate market failures and can potentially increase the effectiveness of a market system 5 Fundamental Questions I What will be Produced o Goods and Services that produce profit Consumer Sovereignty and the Dollar Vote consumers choose what is produced by choosing whether they buy something or not where their money goes is where production is allocated I How will it be produced 0 At the minimal cost depending on the price of technology and the availability of resources I Who gets the product 0 Anyone who is willing and able to pay I How will the market accommodate change a What gets producedhow much is produced depends on consumer tastes technological advancement and resource prices I How will the market deal with riskpromote progress 0 Incentives profit for dealing with risks are the reason that markets continue 0 Circular Flow Model Like the law of conservation of energymatter for physics in economics money does not ever disappear it is exchanged for goods and services by four basic groups Factor Markets resource markets Product Markets Households and Businesses FACTDH MARKET i Households sell 9 Firms Ihuy BIIJSIINIESSES HDUSEHIGILDS a Buy factors ol a Sell fa more D1 prudluctiian prnducrtium i Salli products w Buy prod nuts PHDDUET MARKET 9 Firms sell w Households him Chapter 3 Demand Supply and Market Equilibrium 0 Market A market is anything that allows interaction between a buyerbuyers and a sellersellers 0 Markets exist on the local national and international scale 0 The market for a goodservice determines its price 0 When looking at markets assume I They are competitive I Individual sellersbuyers cannot affect the entire market both are price takers I Perfect Information exists and there is Full Disclosure buyers are aware of all other options and sellers are aware of all potential buyers 0 Demand Curve Mnemonic Hint Qemand goes Qown Represents the sum demand of all individuals willing and able to buy a goodservice Law of Demand as price increases the quantity demanded of a product decreases I Explanations Price is an obstacle Law of Diminishing Marginal Utility As people consume more of a product they will get less satisfied with additional units so to get them to buy you have to Prim Supply Curve 0 Mnemonic Hint Supply goes U lower the price Income and Substitution Effect 0 Average Demand Curve slopes downwards vou must label the price and dugntitv axes Demand 3 Quantum I Change in Quantity Demanded vs Change in Demand a change in the quantity demanded of a product is shown by movement along the demand curve A change in demand is a movement of the entire curve left or right Change in QDemanded Reasons change in the market equilibrium Change in Demand Reasons Consumer Tastes if more people like a product the demand curve will increase shift to the right if more people dislike a product the curve will decrease shift to the left Availability of Substitute and Complementary Goods 0 Substitute Changes that happen to one good can change the demand of a good that can replace the former Example If the price of Pepsi increases the demand for Coke will increase Complementary Changes that happen to one good can change the demand of a good that usually goes with it Example If the price of movies goes up the demand for popcorn will decrease Number of Buyers More buyers higher demand Less buyers lower demand Change in Income with Respect to Inferior and Normal Goods Inferior Goods Products whose demand decreases as income increases Ex Ramen Normal Goods Products whose demand increases as income increases Ex Cars Consumer Expectations If the consumer expects a future price increase the current demand will increase If the consumer expects a future price decrease the current demand will decrease o Represents the sum amount of goods producers are willing and able to sell 0 Law of Supply As price increases the quantity produced increases I Explanations 0 Money is an incentive 0 At some point the costs of production will increase 0 Average Supply Curve slopes upwards vou must label the price and quantity amp d P rice Quantihi Just ignore S1 and S2 They re irrelevant for now I Change in Quantity Supplied vs Change in Supply a change in the quantity supplied of a product is shown by movement along the curve A change in supply is a movement of the entire curve left or right 0 Change in Quantity Supplied Reasons change in the market equilibrium 0 Change in Supply Reasons 0 Change in Price of Resources an increase in the price of a resource used to make a product will decrease the supply and a decrease in the price of the resource will increase the supply 0 Number of Sellers More sellers increased supply Less sellers decreased supply 0 Taxes and Subsidies Taxes will decrease supply usually and subsidies will increase supply usually 0 Prices of Substitute Goods If the price of Coke increases the supply of Pepsi will increase If the price of Coke decreases the supply of Pepsi will decrease 0 Producer Expectations If the price is expected to increase in the future the supply will decrease now If the price is expected to decrease in the future the supply will increase now Chapter 3 Demand and SUDDIV Curves and the Market t Pr39ice Supply Demand Quanf i ty o The intersection of the Demand and Supply Curves is the Market Equilibrium Price and Quantity which means that both sellers and buyers are happy at that price for the product and the amount being producedconsumed 0 Any shift in the Demand or Supply curves will change this point o If the current production of a good lies anywhere that is not the Market Equilibrium point then there is a Surplus or a Shortage I Surplus A surplus exists when the price is higher than the Market Equilibrium price At a higher price suppliers will produce more than people are willing to buy at that price so there is extra product Educational Cunsultants Surplus P lquot i I E Quantity I Shortage A shortage exists when the price is lower than the Market Equilibrium price At a lower price suppliers will produce less of the product than people are willing to buy so there isn t enough product v Burial Price 39 gt a Price Tallinn iii39 a Shortage Damand I I l 39 I I I I l 39 I I Qua rillin o Shifts in the Demand and Supply curves can occur independently or together When they occur together a number of different results are possible I Shift in Supply Shift in Demand Eguilibrium Price Equilibrium Quantig Increase Decrease Decrease Decrease Increase Increase Increase Increase Increase Decrease Decrease Decrease 0 Variations in what can happen exist because the shift in the curves may be greater for one curve than for another As such there are situations where the new Market Equilibrium Price or Quantity may be indeterminate or impossible to say without data represented by quot On the following page are a series of graphs and their explanations as to how shifts in Demand and Supply can affect the Market Equilibrium Pu new Swdv Shaw WM Jugic Wm Wm NE Emmi THE win Pesmm immsr Censmr Mares Wmnms whmh 5 0 d awi m inam a Demmd 3 Si rm 3in 6mm wm E i39ugmoaSE quot b awm D Ee PMua mmgies E L m w Pia 203quot 339cm mxom s 1 5 Gambinin Above Tm Emma39s inamse m magn w wE m M Emma in 91mm wfh m aagmge 39 A a F E Cm i mm E Wn Bammd Swa b945de can Whi n L 1 heme de Pemva 39 R anAisw MGWS D an anew62MB m mam m mmam Pris8m mamas EMqu was Na fach m f Max665 Emmaion dz omn i JamiGa GhmPa P39 Th3 wan P i f W 51951 a iimmih m 5 BMW 4 wn ian 3 CL de wmir m SJPW S b wmas SM E1 Piping dacmises g P EE me l 39 immousas I711 1 Lb J i Q 311 in Price uf hmm di ar m Imam 0 Government Intervention in the Market 0 Sometimes the market alone does not operate at true efficiency and the government may find it necessary to intervene I Price Controls 0 Price Controls are used when the current price of a product is not allowing for full efficiency They are used to correct or sometimes even cause shortages and surpluses 0 Price Ceilings 0 Price Ceilings are used to set a maximum price for a GoodService If they are effective then they will cause a shortage because they are placed below the Market Equilibrium price quot Eurmllr Printre quot n y P39rice milling quot lf Slitfrtalnquot Jllamamd I I I fizualnrliltfglr I I 0 Price Floors 0 Price Floors are used to set a minimum price for a GoodService The best example is minimum wage If they are effective then they will cause a surplus Education gommm I away 0 Minimum Wage and Effects 39Zn quotFM rnwnga por bobs ne SwPPlY 5 Prev 6360 b worKers and he Desmond I s 1hou caP he rms Pirate Chic36 a Proe 100 P3 1 l P6 W 1 I l i 1 I 5 I i f II Dede o4 m FWms GA gt 132W GwanwHr o4 Worker s ampmampw ther39t 39C Sle repmsenas We QwundhiJIY Ga warmers whlir39IS 0 warK 39F39Dr Fe 9116 oure 915 htmd by 1th 1 QA mmsens m GW1V ox mrker39s l rsadr S uPPlieFS WI now him 39 Gw nepmsen t g me Jet om rumban op worKers will 3905 0 NorK 39 P 39r m th is m Wempaovmen becamsa The numbe 013 workers wa39uins 9 mm 4 ch P6 is 0 We numbe 39 DP WOPKEV S 0 Pu rm Win hive Cut PB A Pg mam is memplormanr baseabuse Hue mm be oP wonKer39S Winsna 0 WOPK 439p P4 Gtw 35 Summer han 1 113 nmbev 015 WKePSmF39 vm rs whuna 0 sauna at P42 quot run was Scenario cun cad tempt by m sove rnmw an 0 My mamme E39sSues QC ruml f causes CL Shoe racae 09 Babs o ncj a 5 4 Finlan 0 1quot bQI K81 5 0 Effectiveness When talking about Price Controls effective simply means that it is actually changing the situation Externalities Elsawe Ent er nwi39l f NomiNe ExtemoHT A P P we WW6 M61 MC MCquot WBinm Cos MB mama Wm M017 MB MB We 30V6mmen Will The Bavemmen39f wan amibw gourmetm sumv w cumm 43 F hamam exemmies Shame 1118 SuPPw to COT Pecl 4hr Posmvt exemmts63 Externalities are side effects or consequences of an industrial or commercial activity that affects other parties without this being reflected in the cost of the goods or services involved such as the pollination of surrounding crops by bees kept for honey Externalities can be positive like the bees or they can be negative as in the case of pollution 0 Negative Externalities o Negative Externalities occur when too many resources are being allocated to production of a good The side effects of producing it pollution are more costly than the benefit To correct for negative externalities the government can impose either Direct Controls or Taxes both of which lower the supply I Direct Controls Laws These mostly occur in the form of Pollution Rights Each year there is a set amount of pollution that companies are allowed to produce before they are forcibly shut down The amount they are allowed to create depends on how many of these Rights they own Companies can buy and sell the rights from each other but no new ones are created each yearw I Taxes If the government imposes a tax on the production of a good the producers will make less of it That s pretty much it 0 Positive Externalities 0 Positive Externalities occur when too few resources are being allocated to production of a good The side effects of a goodservice s production are more beneficial than the increased cost To correct for positive externalities the government can Subsidize the firm or they can create Government Provisions I Subsidies If the government pays a producer for making more andor covers the increased cost of making more the producer will make more I Government Provisions When allowing the private market to work on its own some people may not be able to afford certain things In this case the government itself may provide them as an alternative One of the biggest and most valuable provisions that the government provides is Education E wom Mmrtcat Pmoe Per 1w 5mm 1 230007 SuPPl f 1 50000 45 000 Dam and 2 quwd 1 QMMHtY pie Stu66M 600K 759K 39The Wm represenred above dramas the mMKe b 42m edmion 1 mm Priva msiHui ions Creai39t39idmn we edwcod39a 0Y1 SYSte m En emer 0 increase he 0111 lumbar oP smasms betas advocde we sovom menr mus wo OP39HGYBS both are Provisions 39 Scholarships Elmama ScnothhtPs Subs dizn3 bpp le S 39l h f cb l moreoos ms 115 demand This inanemses he Qmar bud39 1150 the Parse a Ntovemenfi P39ik 50000 a 75000 621 600K 2 750 K 39 Public Edm on The Sover39nn sn39r Coon c1150 Wovch 5 own Bdmmrionm gemrecs was increases W SuPPn39 oil edeion Hovcde39rs ThiS Wm 04me Mama GumiY and Decrease Pmce 39 Marnif P42 60000 a 45000 is a won 0 Q1 SOOK 7513K Public versus Private GoodsServices Private Goods 0 Private goods and services are those that are bought and sold by the market s consumers and producers alone Government Law protects private property at least in our system They have two key traits Rivalry and Excludability I Rivalry A good is rivalrous if one person consuming it uses it up meaning someone else cannot consume it I Excludability A good is excludable if you can prevent somebody from using it Public Goods 0 Public goods and services are those that are provided by the government and paid for via taxes Examples are government power water sewage public parks and recreation centers Their two key traits are opposite to those of Private Goods I Nonrivalry When a good is consumed it doesn t reduce the amount available for others I Nonexcludability When it is not possible to provide a good without it being possible for others to enjoy Public Goods also have a problem in the Free Rider Free Riders are individuals that benefit from public goodsservices without paying for them Nobody actually pays for a public good directly but through taxes As such people who don t pay taxes are the general example of freeriders Just pay your taxes the IRS fights aren t worth it Ch 7 The Basics of Macroeconomics o Macroeconomics the part of economics concerned with largescale or general economic factors such as interest rates and national productivity 0 Main Factors The main three factors of Macroeconomic study are GDP GrossDomestic Product Inflation and Unemployment I GDP 0 The GDP is a measure of total expenditure in an economy Essentially it is how much money people have spent on every product that an economy produces The GDP at its most basic is a multiplication problem the amount of final goods sold multiplied by their price Their price is referred to as market value GDP is measured regularly be it yearly or quarterly 3months as it projects economic growth and decline in a nation 0 Final Goods The goods which are intended for the last user Example A tire sold to a car manufacturer is a component of those cars as such it is not a final good instead it is called an intermediate good A tire used to replace a busted one is a final good because the car owner is the one actually using it 0 Restrictions I Things without market value such as doing your own housekeeping are excluded from measurement I Illegal commodities are also excluded 0 Determining the Final Price of a Final Good 7 Disnrmfm ns Final Perez 7 The ncu seih na PM 04quot 6 3 06 is newermm noi ha Smme 05 315 Swm Value 4 9in 7 Price eld Iiiem From 1511 SheoP stden 39 no L119 3439um t W m Wont MW 3 l36 3 GO l Said wool hi Cow W L 5 221 7 40 5016 0 4 7 Cmlh 3 Mannaquot 1 270 w 350 w Sam can 0 4 m Frnml Raw nan 7 350 60 SewardP sens 9 c Vmws 5 H40 350 The mutter m 43mm seller 04 in 42mm 309d sold m can cor 350 9 393m 0 PM 09580 Tms f m Prim is SSSnE s camI I less ncm 39W c sum Vague ac 15 mmnml s wtms hams st mm is no mean aw m setters 0 aomlbumd chcs Winn m7 Awsrr need a Pro ma The sum m2 we mesons is Hm priceosm Hem o The New Circular Flow of the GDP New Caveman Flew NX NT 1 I Resdr Qua We Wor d Swtnss pm n gamma M Enmsmen13 made by Sealers Govemm 39i39 Purchases at 30065 Cnn5umPiO momlms made by Goods Marker 4hr mos New Ewi nal 39u est minus ImPaNS Ne TmS P 39Iquot in w 6M 09 1 0 365 Income 0 When looking at the GDP there is a new Circular Flow model that must be discussed This model adds the Government the Financial Market and all other Economies 0 Using this model there is a way to calculate the GDP of an economy using this equation GDP C I G NX Wherein I C the total spending by households on goods and services For renters this includes rent payments for homeowners this includes rent payments paid to the homeowner but not the purchase price or the mortgage I Machinery Structures Inventories The total spending on goods that make other goods I G Government Purchases and Sales excluding transfer payments such as Social Security I NX Exports Two Approaches To GDP ExpenditureOutput Approach IncomeAllocations Approach Consumption by Households Wages Investment 8er Businesses Rent Government Purchases lnterest Expendituresby Foreigners PrJofit Statistical Adjustments 0 Nominal vs Real GDP and the GDP Deflator 0 GDP is a dollar measurement which presents some problems 0 Nominal A GDP measurement based on the prices that prevailed when output was produced 0 Real A GDP measurement based on a base year price and reflects changes in price level 0 Example I M Lattes Nominal m E Inflation E E Deflator Year Price Quantit Price Quantity Y 2011 10 400 2 1000 6000 6000 1000 000 2012 11 500 250 1100 8250 7200 1146 146 2013 12 600 3 1200 10800 8400 1286 120 I Nominal GDP is Price of that year times the Quantity of that yeah I Real GDP is Price of the base year 2011 times the Quantity of that year I GDP Deflator Nominal GDP Real GDP 100 The GDP Deflator show the average increase in price between two times The difference between two Deflator values is the value of inflation o Shortcomings of GDP I Nonmarket Activities and the Underground Economy are not counted I Improved Product Quality the increase in price may not be due to inflation but product quality increased I Composition and Distribution of the OutputIncome Distribution GDP does not reflect who gets most of the wealth because it assumes equal distribution which is impossible I Noneconomic Sources of WellBeing Other things that don39t Factors Affecting Productivity and GDP Growth with the percentage of times an increase has been because of them Technological Advancement 40 Quantity of Capital 30 Positive and Negative Views of Economic GDP Growth have to be paid for that offer payment in happiness Institutional Structures of GDP Needed for a High GDP Strong property rights Patents and Copyrights Efficient Financial Institutions Free Trade Competitive Market System General Trends of High GDP Literacy and Widespread Education Life Expectancy Education and Training 15 Economies of Scale and Resource Allocation 15 Positive 0 Greater Material Abundance Increased Standards of Living Leisure Time Expansion and Application of Human Knowledge Negative a Larger economies use up more resources and damage the environment more This is due to the rule that growth in Economies increases competition for resources Inflation Rate The rate of Inflation is the average percentage price increase between two years It has an equation in the form of CPI Year 2 CPI Year 1ICPI Year 1 X 100 o CPI Consumer Price Index 0 Measures the typical consumer s cost of living It is the basis of Cost of Living Adjustments COLAs in many contracts and Social Security benefits 0 Calculation I Fix the basket The Bureau of Labor and Statistics uses surveys to determine what the typical consumer buys and sets up a basket of items and services that are bought Find the prices of the items in the basket Multiply the prices to the amounts to find the total cost of the basket I Choose base year and compute the index Cost in Current YearCost in Base Year X 100 I This value which is the CPI can be used to find the Inflation rate in a given year 0 Example I Assume the Typical Basket is 4 Pizzas and 10 Lattes Year Price Price Basket Inflation Rate f of Cost Pizza Latte 2010 10 2 60 100 x 6060 100100 100 0 100 2011 11 250 69 100 x 6960 115100 100 15 115 2012 12 3 78 100x7860 130115115 13 130 0 Problems with CPI It is not a perfect measurement I Over time some prices increase faster than others I Consumers substitute higher priced goods for ones that become relatively cheaper which mitigates the price increase effect CPI calculation misses this because the basket is fixed for a number of years because it is difficult for the BLS to do its data collection I Increases in the CPI tend to overstate increases in the cost of living 0 Contrasts Between CPI and the GDP Deflator I Imported Goods CPI does use GDP Deflator does not use I Capital Goods CPI does not use GDP Deflator does use I The Basket CPI has a fixed basket GDP Deflator uses current production 0 Correcting Variables for Inflation Comparing Money Figures for Different Times I Ex Minimum Wage Did the minimum wage have more purchasing power then or now 0 1964 115 2010 725 0 To compare use CPI to convert 64 to 10 0 in Today in Year T x CPI TodayCPI Year T 0 809 115 x 2203313 Where the CPI in 2010 is 2203 and the CPI in 1964 is 313 I Purpose Indexation a amount is indexed for inflation and is auto corrected for inflation either by law or in a contract I Inflation is a general increase in prices and fall in the purchasing value of money 0 Income Distribution 0 Administrative Inefficiencies 0 Effects on Creditors and Debtors 0 Real vs Nominal Interest Rates I Real Interest Rate Nominal Rate Inflation Rate I Ex A 1000 loan with a 9 Interest Rate and 35 Inflation Rate I Real Interest rate is 55 The higher the Rate of Inflation in comparison to the Interest Rate the more the situation favors the debtor instead of the creditor If the Interest Rate was 35 and the Inflation Rate was 9 then the Real Interest Rate would be 55 which means that in effect the debtor will pay less than the loan back Unemployment Labor Force The adult population excluding Elderly Severely Disabled Hospitalized Jailed Military and FullTime Students It includes both the Employed and Unemployed 0 Labor Force Participation Rate 100 x labor forceadult population Unemployed The portion of the population that is searching for work but does not have it o Unemployment Rate 100 x of unemployedlabor force Duration of Unemployment 0 Typically 13 for under 5 weeks the other 23 for under 14 weeks 0 Usually only 20 of unemployed are so for over 6 months 0 Most observed unemployment is longterm The small group that is longterm has fairly little turnover Natural Rate of Unemployment The normal rate around which the actual fluctuates Frictional Structural Cyclical Unemployment is the deviation from the Normal Rate and is parallel with business cycle 0 Frictional Occurs when workers spend time searching for the job best suited to their skills 0 Structural Occurs when there are fewerjobs than workers o Sectoral Shifts Changes in the composition of Labor Demand what types of workers are more desirableneeded than others This contributes to Frictional and is normal 0 Labor Force Statistics 0 Produced by the BLS based on a regular survey of 60000 households and an adult populationquot that begins with age 16 0 Issues with Unemployment Rate 0 Doesn t show the Discouraged Worker Stat or the Downgrading Stat employees with higher education forced into lower level jobs by circumstance 0 Government Assistance 0 Government Employment Agencies that provide information about jobs 0 Public Training Programs to train workers for specific tradeskill jobs 0 Unemployment Insurance that protects workers income for a set time penod Ch 10 Basic Macroeconomic Relationships 0 GDPCIGNX 0 Each of the individual components of Consumption Investment Government Spending and Net Exports respectively impact the GDP 0 Consumption I Consumption is a portion of an individual s Disposable Income which is defined as the income received after taxes Disposable Income Consumption Spending Savings I People are able to spend more than their Disposable Income due to the ability to borrow money and sell assets Spending more than your DI is called dissaving and is where Savings is negative and Consumption gt DI I Average Propensity A measure of how much a person tends to consumesave 0 Average Propensity to Consume APC Consumption Disposable Income 0 Average Propensity to Save APS Savings Disposable Income 0 APS APC 1 as a result of what is not consumed is saved rule I Marginal Propensity A measure of the change in how a person consumessaves with a change in income 0 Marginal Propensity to Consume MPC Change in Consumption Change in Disposable Income Represents how much of each new dollar of income is used for consumption 0 Is the slope of the Consumption ScheduleFunction o Marginal Propensity to Save MPS Change in Savings Change in Disposable Income Represents how much of each new dollar of income is used for savings 0 Is the slope of the Savings ScheduleFunction 0 MP0 MP8 1 as a result of what is not consumed is saved rule O ring 52000 1 I I E Consumption function 39 I I In t 0 Consumption sav billions ofdollars I uo 500 I 300 I quot Sa vifg I A I a I39Liiinctlon iE39 I IM r 39 300 500 550039 1000 1500 2000 iDiSpoSablE39 poisonal inme billions of39dnllars o This graph shows the relationship between the MPC Curve Consumption Function and MPS Curve Savings Function Where Consumption is to the 45 line Savings is O This is the BreakEven point Prior to this point the distance between the MPC Curve and the 45 line was equal to the absolute value of the distance between the MPS Curve and the xaxis o Determinants of the Consumption Curve The Savings Curve changes in the opposite direction of the Consumption Curve except when taxes change during which they go in the same direction More consumption Curve shifts up while Savings Curve shifts down and vice versa 0 Wealth More money more consumption Curve shifts up 0 Borrowing You have more available money so more consumption 0 Expectations If you expect prices to be higher tomorrow consumption function increases for the present and decreases in the future 0 Real Interest Rates Lower Real Interest Rates on Loans means you re paying less so Consumption Increases o Taxation Tax increases mean both curves go down and Tax decreases mean both curves go up Investment Investment has a demand curve just like products Its axes are different in that the Xaxis is the amount of money that a company which is what generally do this is willing to invest and the Yaxis is the Real Interest Rate Real Interest Rate is the Expected Rate of Return r Nominal Interest Rate i 0 Expected Rate of Return Net Profit Additional Profit Cost I Cost Investment is made if r gt g i Firms continue to invest while r gt i and stop when r i 00 OI Investment demand curve Interest rate percent l l l l I l I l I l I l I I l I I I I l I l I l l A 950 1000 Investment per year billions of baseyear dollars 0 The lower the Real interest rate more money is invested o Determinants of Investment Demand 0 Acquisition Maintenance Operating Costs Increasing costs to for having something will decrease the curve while lower costs will raise the curve 0 Business Taxes If businesses have less money to spend because of increased taxes the curve will lower but if taxes lower the curve will rise as they have more money to spend 0 Technological Change Businesses will be more willing to invest if the tech is better and less willing if it is worse 0 Stock of Capital If a business already has a lot of capital goods they won39t invest as much but will invest more if they don t have enough 0 Expectations If businesses expect the Real Interest Rate to be lower tomorrow they will wait until then but if they expect it to be higher they will increase investment now 0 The Multiplier Effect I The spending of individuals has a tendency to create a ripple effectquot in the economy This is the multiplier effect These small changes in consumptionsavings generate larger changes in the Real GDP 0 Multiplier Change in Real GDP Initial Change in Spending Change in Real GDP MultiplierX Initial Change in Spending O o Multiplier 11 MPC 1IMPS o Other factors affecting the Multiplier 0 Consumers Buy Imported Products 0 Households Pay Income Taxes 0 Inflation 0 Practice Table I 1 g H M m AZAl A3A1 Disposable Income Consumption Savings APC P P MPC MPS 480 488 8 101 01 8 2 520 520 0 1 0 8 2 560 552 8 98 02 8 2 600 584 16 97 03 8 2 640 616 24 96 04 8 2 680 648 32 95 05 8 2 720 680 40 94 06 8 2 760 712 48 93 07 8 2 800 744 56 93 07 8 2 Ch 12 Addredate Demand and Suoplv The Aggregate Demand and Supply Graph projects the economy itself as it is in essence a graph of the entire GDP The GDP is the Xaxis and Price Level is the Yaxis Aggregate Demand Curve The sum of pretty much all market demand curves Price revel HID Real GDP Figure 1 An aggregate demar d curve I Explanations 0 Real Balances Effect Increased consumption as price falls increases GDP 0 Interest Rate Effect Due to interest people pay more respective to amount 0 Foreign Purchases Effect The higher prices go the more people in an economy buy from others at a lower price I Determinants of Aggregate Demand Because the graph is comprised in one aspect of the GDP changes in the parts of GDP Consumption Investment Government Spending and Net Exports change the Aggregate Demand Curve Increasingraising the Curve is a rightward movement and DecreasingLowering is a leftward movement 0 Changes in Consumption 0 Consumer Wealth Increases in Wealth increase Consumption which raises the curve Consumer Expectations Household Debt The higher household debt is the less they tend to spend so the lower the curve 0 Taxes Higher taxes lower consumption which lowers the curve and inversely 0 Changes in Investment Spending 0 Interest Rates If real interest rates decrease then so does the curve 0 Expected Returns I Expected Future Business Conditions If business is projected to be more profitable later the curve lowers in the present as investment lowers in the present and the curve raises in the future as investment raises in the future I Tech More valuable tech raises investment which raises the curve I Degree of Excess Capacity too much extra capital lower investment lower curve I Business Taxes Higher taxes lower investment lower curve 0 Changes in Government Spending I Increases in Government Spending raise the curve and the inverse 0 Changes in Net Export Spending This can t be price level related I Exchange Rates 0 Dollar Appreciation Our currency is more valuable so people buy more imports and businesses export less because other countries can t buy as much Lowers the curve 0 Dollar Depreciation Our currency is less valuable so people buy less imports and businesses export more because other countries can afford more 0 Aggregate Supply The sum of all supply curves in the market 0 There are three different aggregate supply curves I Immediate ShortRun Supply ls horizontal because no matter how the price changes businesses do not have enough time to adjust to the price because they are generally s cky Price Level horizontal ImmediateSherIRun aggregate supplyr I Real GDP I ShortRun Supply ls curved because businesses can adjust to regain profitsminimize losses Pri ce Level A5 GDP I LongRun Supply ls vertical because the amount that everyone wants as a whole will stabilize as time progresses and it doesn t matter what happens to the price level To sum it up everyone is dead in the long run so the quantity needed is meaningless versus the pnceleveL Price Level 0 Real ulpu l o Determinants of Aggregate Supply I Price of Domestic Resources Labor Capital Land If prices go up supply decreases I Prices of Imported Resources Oil and Exchange Rates If import prices increase then supply decreases If the value of the dollar depreciates then there will be less imports because they can buy less essentially price increases and if it appreciates then there will be more imports because they can buy more essentially price decreases I Real Output per Unit of Input 0 Increases in Productivity reduce costs while Decreases increase costs Higher costs mean lower supply L o ProductIVIty W and PerUnit production costs toigtlcyozttpczst o Equilibrium and Shifts FENCE v 39 VS a I quotquot Ia LDE Abl Aggregate Demand and Supply tr 0 Fllgltli 18 o The point E1 represents the initial equilibrium of the Aggregate Market I Shifts in Demand Only 0 If Demand increases then the new equilibrium will be represented by E2 This kind of shift is called PullInflation and causes an increase in the price level and the GDP 0 If Demand Decreases then the new equilibrium point would be lower and to the left of E1 and this kind of shift is a Recession o Recessions have an impact because prices are downwardly inflexible which means that businesses don t tend to lower their prices very easily due to I Fear of Price Wars If one business lowers price the others have to as well to make profit and then it ends up being a competition that tanks everyone I Menu Costs The cost of redistributing the new information is high I Wage Contracts Businesses can t just ignore the deals they have with unions etc Efficiency Wages They expect the downperiod to be short Minimum Wage Law They can t change how much they pay so lowering the price would respectively increase the cost of operating I Shifts in Supply Only 0 If Supply decreases then the new equilibrium will be represented by E3 This shift is called CostPush Inflation and increases the pricelevel while decreasing the GDP This occurs freely because prices can always increase freely they just can t decrease likewise o If Supply increases then the new equilibrium will have a lower price level and a higher GDP This is Full Employment and tends to side with an increase in Demand as well Ch 13 Fiscal Policv o Expansionary This fiscal policy is used to push the economy out of a recession by increasing Aggregate Demand 0 They can do this by increasing government spending lowering taxes a combination of the two or running a deficit o Contractionary Used to correct demandpull inflation If the Aggregate Demand increases too much then the government can force it to a more reasonable level 0 Done by decreasing spending raising taxes a combination of both and creating a surplus 0 Determining whether to change Government Spending or Taxes 0 To expand government I If there is a recession increase spending and if there is inflation then increase taxes 0 To decrease government I If there is recession decrease taxes and if there is inflation decrease spending 0 Automatic Stabilizers of Alterations to the Economy 0 These stabilizers naturally mitigate the effects of the business cycle as best they can They reduce instability but do not remove it I Taxes Vary Directly with GDP If GDP increases Taxes increase and the opposite I Transfer Payments Vary Inversely with GDP If GDP decreases then things like Unemployment Insurance will increase and the opposite 0 Tax Progressivity I Progressive Tax System Increases in income increase taxes I Proportional Tax System There is a flat tax I Regressive Tax System Increases in income decrease taxes and the opposite o How Taxes and Government Spending Work as Stabilizers 200 I o Recessions cause a fall in GDP and as they do deficits will occur in order to alleviate the created problems This is represented by the area below the Government Purchases line horizontal and above the Tax Revenues line angle 0 Expansions cause a rise in GDP and as they do surpluses will occur to decrease the potential inflation effectsThis is represented by the area above the Government Purchases Line and below the Tax Revenues Line 0 Fiscal Policy Forms I Expansionary policies designed to increase aggregate demand I Neutral policies that are designed to keep the status quo I Contractionary policies that are designed to decrease aggregate demand I Criticisms and Problems with Enacting Fiscal Policy 0 Timing Problems While trying to correct a system issue it might change more or right itself in the time period it takes to make the corrections 0 Recognition Lag It takes time for officials to understand exactly what is happening 0 Administrative Lag It takes time to determine what the most effective way to deal with 0 Operational Lag It takes time for implemented policies to actually take effect 0 Other Factors 0 Political Business Cycles changes in the elected officials can affect the main aspects of the business cycle such as inflation and unemployment 0 Future Policy Reversals Expected changes in how the fiscal policy worksis enacted can change the effects of current policies 0 Offsetting State and Local Finance The policies of state and local governments tend to worsen problems because they have significantly more hoops to jump through than the Federal Government 0 The Crowding Out Effect Fiscal policies of the Feds may cause changes in the interest rate and private spending that either cancel out or completely ignore the intention of the aid Increases in publicspending may decrease privatespending which worsens the problem for the private market 0 Current Issues 0 Income Distribution The idea that income is distributed in such a manner that the rich become richer while the poor become poorer due to interference in the market Ch 14 16 Money Banking and Monetary Policv Money is a means of exchange that is used as a unit of measuring value Anything can be considered money from this definition but in order to stabilize the market system currency like the dollar is used 0 Money is valuable because it is scarce The supply of physical money is tightly controlled by the Federal Government to prevent rapid inflation or depreciation of value 0 Fiat Money Any currency that has no inherent value coins paper money etc is Fiat Money It is a standin for the items that have the value I Fiat Money exists because it is much easier to regulate and watch than direct currency such as gold I It is also referred to as legal tenderquot which just means that it s what is accepted as payment by law 0 Definitions of Money I M1 0 M1 is any money that is used for transactions to merchants banks etc It is the physical money or representation of it in the form of checks 0 Coinscash demand deposits traveler s checks any form of checkable deposit 0 M1 money is highly liquid can be used quickly and rapidly with little to no loss of value and as such all currency held by the US Treasury and checkable deposits kept by the government or Federal Reserve are excluded 0 M2 is all of M1 plis any money market shares savings accounts containing less than 100000 and shortterm deposits deposits less than 100000 0 M2 is less liquid than M1 because it has a tendency to lose value in its exchange from where it is held to cash and is also a store of value for the currency The Federal Reserve 0 The authority of the Government that controls the money supply Controlled by a 7 member Board of Governors each of which are appointed by the President for a 14year term staggered to replace one Governor every 2 years 0 Federal Reserve Banks are quasipublic in that they act under private government ownership and public influence They are the banks of banks in that they make the loans to commercial banks that commercial banks make to citizens They function to support commercial banks that need help in crises 0 Federal Open Market Committee I A committee of 12 individuals the 7 Governors of the Board the president of the New York Federal Reserve Bank and four of the presidents of the remaining 11 Federal Reserve Banks rotating yearly This committee meets to control the sales and purchases of government securities in order to control both the money supply and the interest rate that commercial banks act on a They DO NOT set the interest rate that patrons pay to banks They set the interest rate that the Federal Reserve Banks charge those commercial banks for the loans they take out This acts as a mechanism by which the interest rate the banks use is created 0 Functions I Control supply of money set Reserve Requirements lend to commercial banks act as the fiscal policy manager for the US Government supervise commercial banks and mint money The Banking System and the Creation of Money O BanksFinancial Institutions serve as middlemen between those who have money to lend and those who need that money These can be in the forms of Commercial Banks Savings amp Loans Associations Insurance Companies Credit Unions and Pension Funds I These institutions as businesses have the primary goal of making a profit because they are private corporations owned by stockholders They makegenerate money by borrowing from depositors can be account holders or the Federal Reserve and lending that money back out at an interest rate higher than the one they pay to the depositors They also get profit through service fees planning assistance etc Banks function to keep depositors money safe make loans and create money Fractional Reserve Banking 0 Banks lend out most of the money that depositors give them The money that they keep is usually only because they are required to by Required Reserves laws of the Federal Reserve In order to keep the required amount of reserves safe they may be deposited at the local Federal Reserve Bank 0 Reserves are any cash a bank has in the vault plus those deposited at a local Federal Reserve Bank Banks earn no interest on these deposits because they can t loan them out 0 Required Reserves Banks are required by Federal Law to keep a certain percentage of the deposits they receive in either its own vault or the Federal Reserve Vault in order to ensure that any person wanting to make a withdrawal is able to do so The amount the banks are required to keep is called the Required Reserve Ratio I The current rates stand at 10 on deposits totaling over 795M 3 on deposits totaling between 124 and 795M and 0 below 124M I Panics Runs on the Bank 0 Simultaneous withdrawals of several depositors will drain all of a bank s reserves extremely quickly Since these reserves are all that banks have on hand since the rest is out in the form of loans these Panics can kill a Bank These Panics are caused by o Belief that bank doesn t have enough money in its reserves so you want to get yours out first 0 Knowledge or rumors that the bank has made bad loans 0 These Panics and their damage can be mitigated by insurance systems such as the FDIC which insures checkable deposits up to certain limits I Bank Failures Occur when a bank cannot pay its creditors or is unable to pay the withdrawals 0 Examples 0 Farm Loan Default Farms have variable revenue dependent on weather production and the market 0 Foreign Loans Large development projects may not have the returns that were originally expected 0 Commercial Loans development projects like resorts oil drills etc may not have the expected returns I Balance Sheets 0 Bank Balance Sheets show the assets liabilities and net worth of the organizations 0 Assets Things banks own that have value I Cash in the vault reserves at the Fed loans to individuals and businesses govt securities loans to other banks land buildings equipment 0 Liabilities Debts banks owe to other banks I Checking account deposits savings account deposits time deposits borrowing from Fed banks borrowing from other banks 0 Net Worth Assets Liabilities o The Money Multiplier o The multiple by which the total supply of money can increase for each 1 increase in reserves this is because any increase in bank reserves has a larger increase in the money supply due to the effect of loans This multiplier is dependent on the required reserve ratio 0 Multiplier 1 R I R is the Required Reserve Ratio I If the Reserve Ratio is 10 then them Multiplier will be 10 therefore for every 1 increase in reserves there is a 10 increase in the money supply 0 The Interest Rate 0 The price paid for the use of money It is determined by the intersection of the money supply and demand The supply of money is inelastic vertical because there is a set amount of it total the amount n circulation just varies The demand is composed of both the Transaction Demand demand for money due to economic activity and Asset Demand demand for money as store of value which varies inversely with the interest rate Eupp lljr I terest Rate g Ellennan Iz l I Quantity Elf Man2y 0 Interest Rates and Bond Prices have an inverse relationship An increase in bond price will lower the interest rate
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