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Econ 201 Exam 3 Study Guide

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by: Ekene Tharpe

Econ 201 Exam 3 Study Guide ECON 201

Ekene Tharpe

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About this Document

Covers all key terms and calculations that will be present on exam 3 in detail.
Intro Economics: Survey Course
Donna Bueckman
Study Guide
50 ?




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"If you want to pass this class, use these notes. Period. I for sure will!"
Eldon Emmerich PhD

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This 6 page Study Guide was uploaded by Ekene Tharpe on Saturday April 2, 2016. The Study Guide belongs to ECON 201 at University of Tennessee - Knoxville taught by Donna Bueckman in Fall 2015. Since its upload, it has received 298 views. For similar materials see Intro Economics: Survey Course in Economcs at University of Tennessee - Knoxville.


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If you want to pass this class, use these notes. Period. I for sure will!

-Eldon Emmerich PhD


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Date Created: 04/02/16
ECON  EXAM  3  STUDY  GUIDE     Barter  system:  double  coincidence  of  wants;  difficult  and  can  be  inconvenient     Functions  of  Money:   1. Medium  of  Exchange:  buyers  give  to  sellers  for  G&S   2. Unit  of  Account:  measuring  tool  people  use  to  record  debt  and  make  prices   3. Store  of  Value:  item  that’s  purchase  power  lasts  from  present  to  future   4. Standard  of  Deferred  Payment:  not  only  exchangeable  today;  can  buy  today  and   pay  in  the  future     Types  of  Money:   1. Commodity  money:  material  with  intrinsic  value  (ex.  Gold)   2. Representative  Commodity  money:  represents  commodity     3. Fiat  money:  “money”  w/o  intrinsic  value;  used  because  of  gov’t  decree     The  Money  Supply:  quantity  of  money  available  in  the  economy       • Currency:  paper  bills  and  coins  in  the  hands  of  the  public  (non-­‐bank)   • Demand  deposits:  Bank  account  balances  that  depositors  can  access  w/  a  check   (checkable  deposits)   • Measuring  money   o M1:  Currency,  Checkable  deposit,  Traveler’s  check   o M2:    M1  plus  savings  deposits,  small  time  deposits,  money  market  mutual   funds,  (cant  be  accessed  immediately)     Fractional  Reserve  Banking  System   • Banks  keep  reserves  (fraction  of  deposits)  and  the  rest  is  given  out  as  loans:     Based  on  Goldsmith’s  principle   • How  they  bank  makes  money   • Fed  (The  Federal  Reserve):  set  reserve  requirements;  monetary  policy  tool   o Regulate  minimum  reserve  amounts  (the  fraction   • Reserve  Ratio,  R:  fraction  of  deposits  held  as  reserves   o Total  reserves  are  a  percentage     • Banks  Reserve  Holding:   o Require  Reserve:  bank  must  hold   o Actual  Reserve:  what  bank  really  holds   o Excess  Reserve:  amount  beyond  what  bank  must  hold                                                  *Actual  Reserve  =  Required  Reserve  +  Excess  Reserve       The  Money  Multiplier:   • The  amount  of  money  the  bank  system  creates  from  each  $1  of  reserves:        $1/R     Bank  T-­‐account:  Statement  showing  assets  and  liabilities   • Assets:  what  bank  owns   • Liabilities:  what  bank  owes  to  deposit   • Bank  Capital:  resources  bank  gets  by  issuing  equity  to  its  owners   o Also  bank  assets  minus  liabilities         • Leverage:  borrowed  funds  pay  for  existing  funds;  investment  purposes   o Leverage  Ratio:  ratio  of  assets  to  banks  capital       2008-­‐09  Financial  Crisis:   Banks  suffered  losses  in  mortgage  loans  and  in  backed  up  securities.  Caused  by   widespread  defaults.   • Credit  Crunch:  banks  reduce  lending  because  they  have  too  little  capital     o Fed  and  Treasury  can  inject  money   • Capital  Requirement:   o Gov’t  regulation  specifying  minimum  amount  of  capital-­‐  ensure  banks  can   pay  off  depositors  and  debts;  a  buffer     Measuring  the  Cost  of  Living:   • Consumer  Price  Index  (CPI):  Key  measurement  of  inflation  use  in  the  U.S   o Use  Bureau  of  Labor  Statistics  (BLS)  to  calculate     o Measures  ‘typical’  consumer  cost  of  living   ⋅ COLA  basis:  costs  of  living  allowances/adjustments     Calculating  CPIs:   1. Make  “Basket”  =  consumers  surveyed;  determine  typical  ‘shopping  basket’   2. Find  Prices   3. Calculate  basket  cost   4. Select  a  base  year  and  calc.  index   5. CPI  in  any  year  equals   =  100  X  (cost  of  basket  in  current  year)/(cost  of  basket  in  base  year)   6. Calc.  Inflation  Rate:   a. The  percentage  of  change  in  the  CPI  from  the  previous  period   b. Inflation  Rate  Equals     =  (CPI  this  year  –  CPI  last  year)/(CPI  last  year)  X  100     CPI  Problems:   1. Issue  Measuring  Cost  of  Living   a. Substitution  bias:  prices  change,  we  change.  However;  the  Basket’s  fixed   2. New  Good  Introduced   a. Not  included  in  CPI  since  new   b. Quality  change  not  measured       CPI  Use:   • Indexation:  Automatic  correction  of  inflation  by  contract  or  laws   o COLA  (cost  of  living  allowances/adjustments)  in  multi  year  labor  contracts   o Adjustments  in  federal  income  tax  bracket  and  social  security  payments   • Compare  Price  Over  Time:   Amount  in   Amount  in  T   CPI  (Price  level)  “today”   “today’s”   dollars   dollars   CPI  in  year  T     o  CPI  can  adjust  figures  (costs)  so  they  can  be  compare  over  time     • Real  vs.  Nominal  Interest  Rates:   o Nominal  Interest  Rate:  Rate  of  growth  measured  in  Face  (dollar)  value  of  a   deposit  or  debt.  NOT  corrected  for  inflation   o Real  Interest  Rate:  Rate  of  growth  in  measured  in  purchasing  power  of  a   deposit  or  debt.    Corrected  for  inflation   *Real  Interest  Rate  =  Nominal  Interest  Rate  -­‐  Inflation     Cost  of  Inflation:          “Inflation  erodes  real  incomes”=  FALSE     • Inflation:    the  general  increase  in  prices  of  things  people  wish  to  buy/sell   o Cause  CPI  and  nominal  wages  to  increase  together  over  long  term     • Misallocation  of  resources  create  relative  price  variability   o Not  all  prices  rise  at  the  same  time  “blurred  price  signals”   • Inconvenience  and  inconvenience     o Inflation  alters  “yardstick”(Unit  of  Account),  thus  complicating:   ⋅ Planning  long  range   ⋅ Comparing  dollar  amounts  over  time   • Hyperinflation:  Inflation  passing  50%  per  month   o Gov’t  prints  too  much  money:  chasing  same  goods,  prices  increase       Other  Inflation  Measurements:   • Producer  Price  Index  (PPI)   Bureau  Labor  Stats:     • International  Price  Index   • Employment  Cost  Index   The  ‘best’  measure  of  inflation  for  a   • GDP  deflator   given  application  depends  on  the   • Core  Inflation  Index   intended  use  of  the  data         Deflation:   Downward  pressure  on  price,  not  all  bad   • However:   o Low  output  (economic   growth)  =  Low  employment     § Affects  buyers,  slows  purchasing   o Increases  value  of  debt  =  Increase  burden   § Private  and  private  debt   § Lending  slows   o Create  negative  interest  rates           Gross  Domestic  Product  (GDP):  Income  expenditure   The  market  value  of  all  finial  goods  and  services  produced  within  a  country  in  a  given   period  of  time   Finial  Goods:  for  the  end  user   Intermediate  goods:  used  to  produce  other  goods       Components  add  up  to  GDP   GDP:  Expenditure:  4  components   Y=  C  +    I    +  G    +    NX   1. Consumption  (C):  Total  spending  by  on  G&S  by  a  household   2. Investment  (I):  Total  spending  on:     o Capital  equipment:  help  in  the  production  of  other  G&S   o Structures  (ex.  factory,  house)   o Inventories:  goods  that  have  been  produced,  but  not  sold     3. Government  Purchases  (G):  Spending  on  G&S  by  the  government  at  all  levels   (federal,  state,  local).  Excludes  transfer  payments  (Social  Security,  UI  benefits)     4. Net  Exports  (NX):  NX  =  Exports    –  Imports          (Trade  balance:  Surplus  or  Deficit)       GDP  and  Economic  Well-­‐Being   • Real  GDP  per  Capita:  key  indicator  of  average  persons  standard  of  living     o Real  GDP  per  capital=  real  GDP  population   • GDP  Omissions:   o The  environments  quality     o Leisure  time   o Non-­‐market  activity   o Equitable  distribution  of  income   • GDP’s  importance  to  us:   o Large  GPD  means  the  country  cant  afford  things  like  better  schools,  clean   environment,  health  care,  etc.   o Indicators  of  life  quality  positively  correlate  with  GDP     Business  cycles:     • Short-­‐run  economic  fluctuations  around  the  long  run  trend   § 4  phases:        1.  Peak                          (Back  to  Peak)                                                                                                                                                  2.  Recession                                                4.  Recovery                          3.  Trough     • Recession-­‐  Periods  where  real  incomes  falls  and  unemployment  rises   o Depression-­‐  sever  recession  (rare)     Real  vs  Nominal  GDP   • Nominal  GDP:    Output  at  current  prices.  Not  corrected  for  inflation   • Real  GDP:  Values  output  using  prices  of  a  base  year.  Is  corrected  for  inflation     The  GDP  Deflator:   • It  is  a  price  index  (measurement  of  overall  prices).    Can  be  used  to  calculate   inflation       GDP  Deflator  =  100  X  (Nominal  GDP/  Real  GDP)   Productivity:  output  per  worker   • A  countries  standard  of  living  depends  on  their  ability  to  produce  G&S   o Depends  on  productivity:  The  value  of  output  produced  per  unit  of  labor                                Y  =  Real  GDP  (quantity  of  labor  produced)                  Productivity  =  Y/L                  L  =  Quantity  of  Labor                                                                                                  (output  per  worker)     Factors  of  Production   • Physical  Capital  =  k  =  Equipment  and  Structures  used  to  produce  G&S     o k/L  =  Capital  per  worker   o Productivity  is  higher  when  the  average  worker  has  more  capital     • Human  Capital  =  H  =  Knowledge  and  Skills  workers  acquire     o H/L  =  the  average  worker’s  human  capital     o Productivity  is  higher  when  the  average  worker  has  more  human  capital     • Natural  Resources=  N  =  Nature  provided  imports     o All  else  equal,  more  N  lets  the  country  produce  more  Y   o Countries  don’t  need  N  to  be  wealthy     Technological  Knowledge     • Society’s  understanding  of  the  best  way  to  create  G&S   o Advance  in  knowledge:  increases  production  (more  output  from  resources)   • Technological  change:  Advances  in  knowledge  applied  (intervention/  innovation   combination)     Growth  Polices   • Foreign  direct  investment:  capital  investment  owned  and  controlled  by  a  foreign   entity     • Foreign  portfolio  investment:  capital  investment  financed  by  foreign  money,  but   is  operated  domestically     • Education:  Policy  promotes  investment  in  H  (public  schools,  subsidies  in  college   loans)   o Education’s  positive  externalities:  Each  year  of  schooling,  increase  works   wage  by  10%   o Opportunity  cost:  present  and  future  income   • Health  and  Nutrition:  Healthier  works  =  more  productivity;  investment  in  H   o Malnourished  countries:  raising  caloric  intake  increases  worker  productivity   • Property  rights:  Ability  for  people  to  exercise  authority  over  resources  they  own   o Stable  government  =  stable  constitution  =  law  enforcement   • Political  Stability:  Justice  system=  Enforce  contracts,  address  fraud/  corruption,   have  effective  courts   o Political  instability:  Uncertainty  over  whether  property  rights  will  be   protected  in  the  future  is  created     • Free  Trade:   o Inward-­‐oriented  policies:  limits  on  investments  from  abroad.  Avoid   interaction  with  other  countries   o Outward-­‐  oriented  polices:  eliminate  foreign  investment  and  trade   restrictions.  Promotes  involvement  with  the  world  economy       Population  Growth   • 3  ways  it  can  affect  living  standards:   1. Stretch  Natural  Resources:  Technological  productivity  and  progress   growth   2. Dilute  the  Capital  Stock:     a. Larger  population  =  Higher  L  =  Lower  k/L  =  lower  productivity  and   living  standards       b. Applies  to  H  as  well   3. Promote  Tech.  Progress:  Larger  population  =   a. More  scientist,  engineers,  inventors   b. More  frequent  discoveries   c. Faster  tech  progress/  economic  growth      


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