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EC202 Week 6 Notes

by: Kelsey Fagan

EC202 Week 6 Notes EC 202

Marketplace > University of Oregon > Economcs > EC 202 > EC202 Week 6 Notes
Kelsey Fagan
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Here are the notes for week 6.
Intro Econ Analy Macro
Chad Fulton
Class Notes
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This 8 page Class Notes was uploaded by Kelsey Fagan on Friday May 6, 2016. The Class Notes belongs to EC 202 at University of Oregon taught by Chad Fulton in Spring 2016. Since its upload, it has received 16 views. For similar materials see Intro Econ Analy Macro in Economcs at University of Oregon.

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Date Created: 05/06/16
Day 11 (5/2)  Money Cont.  ● Money is any commodity or token that is generally acceptable as a means of payment   ● Recall:  ○ Definitions of money:  ■ Currency: notes, coins  ■ M1: currency, traveler’s checks, checking deposits  ■ M2: M1, time deposits, saving deposits, money market, mutual funds, etc.  ○ Banks:  ■ Banks take deposits from individuals  ■ Banks have to hold some of those deposits as reserves (required reserve  ratio)  ■ Banks make loans with the rest in order to generate profit  ○ Federal Reserve:  ■ The Fed is the central bank of the United States  ■ The Fed has the following policy tools:  ● Open market operations  ● Last resort loans  ● Required reserve ratios  ○ Money Supply:  ■ The Fed can change the supply of money via open market operations:  ● Purchase securities­ increase the supply of money  ● Sell securities­decrease the supply of money  ● Loans​  create money  ○ When the bank uses deposits from individuals to make a loan, new money is  created  ■ The individual who made the deposit still has their deposit  ■ The firm(or individual) who just got a loan now has (new) money from  their loan   ● Limits to Loans:  ○ Monetary base: the amount of currency issued by the Federal Reserve  ■ If the Federal Reserve ​purchases​ securities from banks:  ● This increases the monetary base  ○ The banks have new currency which they can loan out  ■ If the Federal Reserve ​sellssecurities to banks:  ● This decreases the monetary base  ○ The banks have less currency which they can loan out  ○ Required reserve ratio: the amount of deposits that can be loaned out  ■ If the required reserve ratio is lower:  ● Banks have to hold less of their deposits as reserves  ● Reserves cannot be loaned out; fewer reserves increases the  number of loans  ■ If the required reserve ratio is higher:  ● Banks have to hold more of their deposits as reserves  ● Reserves cannot be loaned out; more reserves decreases the  number of loans  ○ Currency holdings: the amount of currency not deposited into banks  ■ If people hold ​les money as currency (instead they make bank deposits)  ● More deposits are made  ○ Increases the number of loans  ■ If people hold ​more​ money as currency  ● Fewer deposits are made  ○ Decreases the number of loans  ● Currency drain​  is the amount of money held as currency andnot deposited into banks  ○ Currency drain ratio= Currency/deposits  ● Money creation process:  ○ The money creation process begins with the Fed purchasing securities, but it  doesn’t end there:  ■ 1) Fed purchases securities; this increases the monetary base  ■ 2) Because banks have more currency, they now have more reserves than  they need  ■ 3) They make new loans with the excess reserves  ■ 4) A firm (Firm A) receiving the loan now has new money  ■ 5) Firm A then holds some of the new money as currency, and makes  deposits with some of that money  ■ 6) This increase in deposits means the banks can now make even more  loans, with some of those deposits  ■ 7) Another firm (Firm B) receiving the new loans now has new money  ■ 8) Repeat 5­7  ○ Example:  ■ Required reserve ratio is 10%  ■ 10% of the money is held as currency  ● 1) Fed purchases $100 in securities­ this increases the monetary  base (creates new money) by $100  ● 2) Banks now have $100 of excess reserves, and they loan out that  $100 to Firm A  ● 3) Firm A now has $100, and they hold $10 in currency and make  new bank deposits of $90  ● 4) Banks now have $90 of new deposits  ● 5) Banks are required to hold 10% of the new $90 deposits as  reserves, but can make new loans with the remaining $80  ● 6) Banks make loans of $80 to Firm B. This is $80 of new money.  ● 7) Firm B now has $80, and they hold $8 in currency and make  new bank deposits of $72  ● 8) This process will repeat (Steps 4­7)  ○ Why not print money FOREVER????  ■ More money doesn’t change actual state of the economy at all  ○ Quantity Theory of Money  ■ In the long run an increase in the quantity of money brings an equal  percentage increase in the price level.    Aggregate Supply & Demand   ● Aggregate Supply  ○ The ​quantity of real GDP supplied​ is the total quantity that firms plan to  produce during a given period  ○ Aggregate supply​  is the relationship between the quantity of real GDP supplied  and the price level.  ○ Potential GDP= aggregate supply  *Time frames:  Short­run: think about a couple of years  Long­run: think about a decade or so  ○ Long­run aggregate supply  ■ The relationship between the quantity of real GDP supplied and the price  level, when real GDP s equal to potential GDP  ■ Supply curve: a vertical line, because potential GDP inot influenced by  the price level  ■ In terms of wages: The relationship between quantity of real GDP  supplied and the price level, whenominal wages are allowed to adjust  ○ Short­run aggregate supply  ■ The relationship between quantity of real GDP supplied and the price  level, when the real GDP may be different from potential GDP  ■ Supply curve: an upward sloping line, indicating thaas price rises, so  does real GDP  ■ In terms of wages: The relationship between quantity of real GDP  supplied and the price level, whenominal wages are held fixed.  Day 12 (5/4)  Midterm Overview/Notes on Grades  Average score: 70%  Ranges:   ● 80+ in the C range  ● 105+ in the B range  ● 120+ in the A range  *Over the weekend Prof. Fulton will compute an approx. course grade based on the midterm and  homeworks 1­5    Aggregate Supply & Demand Cont.  ● In the short­run:  ○ The money supply is fixed  ○ Real interest rates are fixed  ○ Prices are fixed   ○ Nominal wages are fixed  ● In the long­run (aggregate supply curve):  ○ Vertical because:  ■ It satisfies the law of supply  ■ As nominal wages increase, firms decrease supply  ■ Potential GDP does not depend on prices  ■ Potential GDP never changes  ● Wages  ○ The ​ nominal wage ​(the money wage in the book) is the amount of money you  receive as wages  ○ The ​ real wage is the purchasing power of you wage  ■ Real wage= nominal wage*(CPI in base year/CPI in current period)*100%  ■ CPI in the base year is always 100  ○ Things that can change the real wage  ■ Prices: As prices go up real wage falls and vice­versa  ○ Examples from the Midterm (18+):    Year  Population  CPI  Inflation  Nominal  Nominal  Real  GDP  Wage  Wage  2000  100  100    $200  $8/hour  $8/hour  2001  200  120      $12/hour  $10/hour  2001  300  150    $800  $18/hour  $12/hour    ■ real wage 2000=nominal wage* (CPI base/CPI current)  Real wage=$8*(100/100)= $8/hour  ■ real wage 2001= nominal wage* (CPI base/CPI current)  Real wage=$12*(100/120)=$10/hour  ■ Real wage 2002= nominal wage* (CPI base/CPI current)  Real wage=$18*(100/150)= $12/hour  ● Labor Market (Recall)  ○ Supply: individuals supply labor in return for wages  ○ Demand: firms demand labor and pay wages  ○ Both individuals and firms care about the real wage​, not the nominal wage  ■ Individuals care about how much they can purchase  ■ Firms care about how much it costs to pay workers  ○ Long­run  ■ The real wage is ​ determined by equilibrium in the labor market  ○ Short­run  ■ The nominal wage cannot be changed  ■ The real wage ​ fluctuates as prices change  ●  Aggregate supply (Recall)  ○ The relationship between the quantity of real GDP supplied and the price level  ○ In the ​long­run​, aggregate supply is always equal to potential GDP, and the  aggregate supply curve is vertical   ■ Economic growth change the level of GDP  ○ In the long­run aggregate supply is influenced by potential GDP  ○ In the short­run aggregate supply is influenced by price level   ● Aggregate Demand  ○ The quantity of real GDP demanded is the total amount of final goods and  services produced in the US that people, businesses, governments and foreigners  plan to buy   ○ Things that affect aggregate demand:  ■ The price level  ■ Expectations  ■ Fiscal policy and monetary policy  ■ The world economy  ○ The aggregate demand curve is downward sloping because it satisfies the law of  demand.  ■ Effects:  ● Wealth:  ○ As the price changes so does your wealth level  ● Substitutions  ○ As the price of goods changes, you may want to either wait  to make purchases or purchase foreign goods instead.   ■ Intertemporal: substitution across time  ■ International: substitution between domestic and  foreign goods  ○ Shifts in Aggregate Demand:  ■ Anything other than a price change will shift the curve  ● Expectations  ○ Future income: increases in future income increases  people’s consumption today and increases aggregate  demand  ○ Future inflation: rise in the expected inflation rate makes  buying goods cheaper today and increases aggregate  demand  ○ Future profits: an increase in expected future profits boosts  firms’ investment, which increases aggregate demand  ● Fiscal policy and monetary policy  ○ The government’s attempt to influence the economy by  setting the tax level and making government purchases  ○ Taxes:  ■ A tax cut increases households’ disposable income  ■ An increase in disposable income increases  consumption expenditure and increases aggregate  demand  ○ Government spending:  ■ Because the government expenditure on goods and  services is one component of aggregate demand, an  increase in government expenditure increases  aggregate demand  ○ Monetary policy  ■ The Fed’s attempt to influence the economy by  changing the interest rate and adjusting the quantity  of money   ● An increase in the quantity of money  increases buying power and increases  aggregate demand  ● A cut in the quantity of money does the  opposite.   ● World economy  ○ We’re not alone  ○ If demand for US exports rises, aggregate demand in the  US rises  ● Equilibrium  ○ When supply and demand curves meet (cross)  ○ In the short­run: when the quantity of real GDP demanded equals the quantity of  real GDP supplied    ○ In the long­run: when real GDP equals potential GDP    ● Economic Growth: only happens with a change in potential GDP (increase)       


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