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Macro Economics, Week8 Notes

by: Johanna Glaser

Macro Economics, Week8 Notes ECON 2220-004

Marketplace > University of Nebraska at Omaha > ECON 2220-004 > Macro Economics Week8 Notes
Johanna Glaser
GPA 3.717

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Continuation of chapter 12-14. Test is Wednesday October 19. Happy Studying!!
Principles of Economics-Macro
R. Metz
Class Notes
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This 9 page Class Notes was uploaded by Johanna Glaser on Wednesday October 12, 2016. The Class Notes belongs to ECON 2220-004 at University of Nebraska at Omaha taught by R. Metz in Fall 2016. Since its upload, it has received 15 views.


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Date Created: 10/12/16
Week 8 Investment from Abroad  Investment from abroad o Another way for a country to invest in new capital o Foreign direct investment  Capital investment that is owned and operated by a foreign entity o Foreign portfolio investment  Investment financed with foreign money but operated by domestic residents  Benefits from investment o Some flow back to the foreign capital owners o Increase the economy’s stock of capital o Higher productivity o Higher wages o State-of-the-art technologies  World Bank o Encourages flow of capital to poor countries o Funds from world’s advanced countries  World bank and the international monetary fund o Set up after ww2 o Economic distress leads to:  Political turmoil, international tensions Education  Education o Investment in human capital o Gap between wages of educated and uneducated workers o Opportunity cost: wages forgone o Conveys positive externalities o Public education- large subsidies to human-capital investment o Problem for poor countries: Brain drain Health and Nutrition  Humana capital o Education o Expenditures that lead to a healthier population  Healthier workers o More productive  Wages o Reflect a worker’s productivity  Right investments in the health of the population o Increase productivity o Raise living standards  Vicious circle in poor countries o Poor countries are poor  Because their populations are not healthy  Populations are not healthy  To foster economic growth o Protect property rights  Ability of people to exercise authority over the resources they own  Courts-enforce property rights o Promote political stability  Property rights o Prerequisite for the price system to work  Lack of property rights o Major problem o Contracts are hard to enforce o Fraud goes unpunished o Corruption Free Trade  Inward-oriented policies o Avoid interaction with the rest of the world o Infant-industry argument  Tariffs  Other trade restrictions o Adverse effect on economic growth  Outward-oriented policies o Integrate into the world economy o International trade in goods and services o Economic growth  Amount of trade-determined by o Government policy o Geography  Easier to trade for countries with natural seaports Research and Development  Knowledge-public good o Government-encourages research and development  Farming methods  Aerospace research (Air Force; NASA)  Research grants  National Science Foundation  National Institutes of Health  Tax breaks  Patent system Population Growth  Large population o More workers to produce goods and services  Larger total output of goods and services o More consumers  Stretching natural resources o Malthus: an ever-increasing population  Strain society’s ability to provide for itself  Mankind- doomed to forever live in poverty  Diluting the capital stock o High population growth  Spread the capital stock more thinly  Lower productivity per worker  Lower GDP per worker  Promoting technological progress o World population growth  Engine for technological progress and economic prosperity  More people= more scientists, more inventors, more engineers  Anti-Growth Argument o Not sustainable o Pollution o Resources are consumed and returned to the environment as waste o Growth does not solve sociological problems such as poverty, homelessness and discrimination o Higher standard of living comes with stress, angst, and anomie  Social instability resulting from a breakdown of standards and values; ALSO: personal unrest, alienation, and uncertainty that comes from a lack of purpose or ideals o Summarized by “Gee, the world is not perfect or fair”  Pro-Growth Argument o Path to higher standard of living o More education, recreation, travel, medical care, pollution abatement, equipment, better designed buildings, etc. o More art, music, drama, etc. o Only way to alleviate poverty  There is little political stomach for redistribution o Better equipment to work with, better work conditions o More leisure allows more time for self-fulfillment o Price system assures resource availability for growth o Growth is primarily derived through expansion of human knowledge thus assuring sustainability Chapter 13: Saving, Investment & the Financial System Financial Markets  Financial Markets o Savers can directly provide funds to borrowers o The bond market  Bond- certificate of indebtedness  Time of maturity- the loan will be repaid  Rate of interest  Principal- amount borrowed  Term-length of time until maturity  Credit risk- probability of default  Tax treatment o The stock market  Stock-claim to partial ownership in a firm  Organized stock exchanges  Stock prices: demand & supply  Equity Finance  Sale of stock to raise money  Stock index  Average of a group of stock prices Financial Intermediaries  Banks o Take in deposits from savers  Banks pay interest o Make loans to borrowers  Banks charge interest o Facilitate purchases of goods and services  Mutual funds o Institution that sells shares to the public o Uses the proceeds to buy a portfolio of stocks and bonds o Advantages  Diversification  Access to professional money managers National Income Accounts  Important identities o An equation that must be true because of the way the variable in the equation are defined o Clarify how different variables are related to one another  Accounting Identities o Gross Domestic Product (GDP)  Total income  Total expenditure o Y= C + I + G + Xn  Y=GDP o Closed economy  Doesn’t interact with other economies  Xn=0 o Open economy  Interact with other economies o Assumption: close economy: Xn=0  Y= C + I +G o National saving, (S)  Total income in the economy that remains after paying for consumption and government purchases  In a closed economy  Y=C+I+G  I=Y-C-G  S=Y-C-G  Savings = Investments **  T= taxes minus transfer payments  Private saving, Y-T-C  Income that households have left after paying for taxes and consumption  Public saving, T-G  Tax revenue that the government has left after paying for its spending  Budget surplus: T-G>0  Excess of tax revenue over government spending  Budget deficit: T-G<0  Shortfall of tax revenue from government spending o Macro Identities  Aggregate expenditures= real GDP  Leakages: dollars of income that are not used to create demand for new domestic output  Ex. Personal Savings, imports, taxes  Leakages = injections  Injections: dollars of spending in addition to consumption spending  Ex. Investment spending, exports, government spending o Savings= Investment  For the economy as a whole  One person’s savings can finance another person’s investment The Market for Loanable Funds  Market for Loanable Funds o Market  Those who want to save supply funds  Those who want to borrow to invest demand funds o One Interest Rate  Return to saving  Cost of borrowing o Assumption  Single financial market  Supply & Demand of Loanable Funds o Source of the supply of loanable funds  Saving o Source of the demand for loanable funds  Investment o Price of a loan= real interest rate  Borrowers pay for a loan  Lenders receive on their savings o As interest rate rises  Quantity demanded declines  Quantity supplied increases o Demand curve  Slopes downward o Supply curve  Slopes upward  Government policies o Can affect the economy’s saving and investment  Saving incentives  Tax free bonds  Investment incentives  Tax credits (wind power)  Government budget deficits and surpluses  Policy 1: Saving Incentives o Shelter some saving from taxation  Affect supply of loanable funds  Increase in supply  Supply curve shifts right  New equilibrium  Lower interest rate  Higher quantity of loanable funds o Greater investment  Policy 2: Investment Incentives o Investment tax credit  Affect demand for loanable funds  Increase in demand  Demand curve shifts right  New equilibrium  Higher interest rate  Higher quantity of loanable funds o Greater saving  Policy 3: Government Budget Deficits & Surpluses o Government- starts with balanced budget  Then starts running a budget deficit  Change in supply of loanable funds  Decrease in supply o Supply curve shifts left  New equilibrium o Higher interest rate o Smaller quantity of loanable funds o Crowding out  Decrease in investment  Results from government borrowing o Government- budget deficit  Interest rate rises  Investment falls o Government- budget surplus  Increase supply of loanable funds  Reduce interest rate  Stimulates investments o Budget deficit: the amount by which govt. expenditures exceeds govt. revenues in a given year o Budget surplus: the amount by which govt. revenues exceeds govt. expenditure in a given year o Public debt: “the total accumulation of deficits (minus surpluses) the federal govt. has incurred through time.” Chapter 14: The Basic Tools of Finance Managing Risk  The markets for insurance o Person facing a risk  Pays a fee to insurance company o Insurance company  Accepts all or a part of risk  Insurance contract- gamble o You may not face the risk o Pay the insurance premium o Receive: peace of mind  Role of insurance o Not to eliminate the risks o Spread the risks around more efficiently  Market for insurance- problems: o Adverse selection  High-risk person- more likely to apply for insurance  Ex. Both of Susan’s parents lost their teeth to gum disease, so Susan buys dental insurance o Moral hazard  More hazard is a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost  Ex. Joe takes up sky diving after buying life insurance  Policy:  TARP- protects large financial institutions from failure. They will behave more recklessly because they are protected from adverse outcomes  Diversification o Reduction of risk o By replacing a single risk with a large number of smaller, unrelated risks o Can eliminate firm-specific risk o Cannot eliminate market risk  Risk o Can be measured statistically  Uncertainty o Cannot be measured. Profit  Risk of a portfolio of stocks o Depends on number of stocks in the portfolio  Firm- specific risk o Affects only a single market  Market risk o Affects all companies in the stock market  Risk-return trade-off o 2 types of assets  Diversified group  8% return  20% standard deviation  Safe alternative  3% return  0% standard deviation Asset Valuation  The efficient markets hypothesis o asset prices reflect all publicly available information about the value of an asset  Stock markets o exhibit informational efficiency  Informational efficiency o description of asset prices o rationally reflect all available information  Implication of efficient market hypothesis o stock priced should follow a random walk Market Irrationality  Many believe that sock price movements are partly psychological o J.M. Keynes: stock prices driven by “animal spirits”


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