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Econ 121 notes- updated

by: Lael Wynne

Econ 121 notes- updated 36926

Lael Wynne

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These include the class notes for the week of April 11th.
Principles of Macroeconomics
Class Notes
Econ, Economics, Macroeconomics, econ121, business
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This 6 page Class Notes was uploaded by Lael Wynne on Saturday April 16, 2016. The Class Notes belongs to 36926 at University of Illinois at Chicago taught by Officer in Spring 2016. Since its upload, it has received 8 views. For similar materials see Principles of Macroeconomics in Business at University of Illinois at Chicago.


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Date Created: 04/16/16
Econ Notes (Part 3) All income GDP goes to households Flow-of-Funds equilibrium: o Expenditures on GDP= resource purchases/payments o Sv + T + M = I + G + X LRAS (Long Run Aggregate Supply): 1) Resources ↑ o Labor, physical capital o Human capital 2) Technological change o ↑ productivity of labor o Invention o Innovation- entrepreneur; puts invention to practical use 3) Improvement in institution 4) Work more, less leisure P LRAS1 LRAS2 SRAS1 SRAS2 P1 1 P2 2 Y P1 Yp2 Economic Growth: o LRAS ↑ SRAS ↑ o YP↑ P↓ o Government doesn’t change policies o US & China Economic Growth W/O Cycle: o Slow, steady, outward shift in LRAS o Anticipated/Expected; permanent o Because this economic growth is anticipated, LR equilibrium is never disturbed o Natural rate of unemployment is the same Economic Decline: o LRAS shifts to the left gradually o Everything in reverse Causing the business cycle: 1) Unanticipated shifts in the AD curve & SRAS o Shifts in SRAS: i. Shocks in SRAS- unanticipated and temporary increase in output for any price ii. Negative shock (unfavorable) = decrease in output iii. Positive shock (favorable) = increase; expansion If anticipated (PRES ratio is unchanged and Y remains at YPeven though P varies Expansion (Boom) P AD1 LRAS SRAS AD0 P1 1 YP Y1 Y o Can’t stay at P0 because there’s an excess demand o P↑ = Y↑ ( Point 0 to Point 1) o (P/P ) ↑ Profit ↑ RES o Profitability ↑ LRAS P SRAS0 SRAS1 P1 Y P Y1 Y o At P0, there’s an excess supply o P ↓ = Y↑ o (P/PRES ↑ o Profitability ↑ Contraction (Recession) LRAS AD0 SRAS0 AD1 Y1 YP Y o Inward shift in AD o At P0: excess supply of goods/services o P↓ = Y↓ o (P/PRES ↓ o Profitability ↓ o At Y1: unemployment < natural rate SRAS1 LRAS SRAS0 AD0 Y1 YP Y o Inward shift in SRAS o At P0: excess demand of goods & services o P↑= Y↓ o ↓ in production of resources is greater than ↑ in price o Increase in P is a consequence, not a cause o Profitability ↓ Shifts in AD is caused by change in optimism or pessimism o Business invest a lot ( I↑) (C↑) = AD↑ = Expansion o Pessimism replaces optimism (I↓) (C↓) = AD↓ = Recession Excess supply of labor = unemployment Excess demand of labor = overflow of unemployment Expansion: o W↑ P RES o Pressure in resource labor market o Wages much more flexible upward than downward Recession: o W↓ P RES o Can take a long time (years) for wages to decrease and get back to full employment. Why? o Contracts- set resource prices o Resource suppliers, especially workers, resist reduction of resource price wage Recession is associated with pessimism Cycle caused by shifts in private AD: o I↓ =G↑ o T↓= C↑ Lags in activist fiscal policy (Keynesian): 1) Legislation lag 2) Impact lag (6 mos) 3) Forecasting lag (6-12 mos) Specific problems with K Fiscal Policy: 1) Crowding out o G↑; budget deficit o Demand for loanable funds shifts out (↑) o More expensive for durables to borrow = C↓ investment (I)= ↓ o Increased G has “crowded out” private counterparts of AD; G↑ but C↓ I↓(Physical investment) 2) Foreign exchange market o IR↑ o Net capital inflow ↑ o D for $ increases (currency appreciation) o S of FE increases (currency appreciation) United States services/goods are more expensive for foreigners; foreign goods/services are cheaper to Americans o X↓ M↑= NX↓ (X-M) Recession: o G↑ o IR↑= consumption ↓; investment ↓; NX ↓ o AD doesn’t shift at all or it shifts out but comes right back o All that the fiscal policy has done is changed the composition, real GDP, not the level of GDP Crowding out also occurs all the opposite to inflationary expansion o AD ↑; P↑; Y>P o Expectations of future taxes Reasons why household’s ↑ savings instead of when taxes ↓: 1) T↓ is temporary o Save instead of spend 2) Household (Debt/income) ration is very high o Use reduced taxes to payments to “reduce your debt”; “income savings” 3) Pessimism o Save more not consume more Rent seeking- lobbying of government for T↓ and G↑ o Big business; influence Functions of Banking: 1) Safeguard Functions 2) Pay interest on funds 3) Transfer funds 4) Make loans & buy securities Balance sheet of bank: o Assets: loans, securities, reserves (vault cash; deposits at feds/central bank) o Labilities: deposits Why hold reserves against deposits? 1) Cover withdrawals 2) Cover net check clearing Law- have to have a minimum; minimum reserve requirement o Legal minimum (Reserves/ Deposits) o Way of controlling/determining the money supply o Assumption: 10% Multiple credit creation- banks make loans by creating deposit liabilities upon themselves Excess reserves= (Actual reserves-required reserves) Example: o $100 excess reserves o Only bank in the country (monopoly bank) o No currency o Fully loaned up- excess reserves are 0 ↑Loans= ↑Deposits Excess Reserves Required Reserves $0 100 0 $100 90 10 $90 81 9 $81 72.9 8.1 Change in deposit= (deposit expansion multiplier)*(excess reserves) o Deposit expansion multiplier = (1/req reserve ratio) What can go wrong? 1) Small bank can safely sent out only excess reserves 2) Depositors take out loan partly in currency or cash in some or all deposits they can get from loan o People/firms want currency initially 3) Customers/firms/households don’t want to borrow 4) Banks don’t want to lend o Scared of creating deposit liabilities because they might not be paid back Distinguish theoretical deposit expansion multiplier verses the actual expansion multiplier Central Banking: o Commercial banks o Savings & loans (S & L) o MSB’s o Credit unions Federal Reserve: o 12 federal banks in the United States o Board of governors; 16 year terms o Janet Yellen- chairman o Tries to determine the money supply


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