Unit 7 - Absolute/Comparative Advantage (5-9-16)

Absolute Advantage

Individual: exists when a person can produce more of a certain good/service than someone else in the same amount of time. (or can produce a good using the least amount of resources)

Natural: exists when a country can produce more of a good/service than another country can in the same time period.

Comparative

• producer with the lowest opportunity cost
• a person or a nation has a comparative advantage in the production of a product when it can produce the product at a lower domestic opportunity cost than can a trading partner

Output:

• tons per acre
• miles per gallon
• words per minute
• apples per tree
• tv's produced per hour

Input:

• number of hours to do a job
• number of acres to feed a house
• number of gallons to paint a house

 

Specialization and Trade

•  Gains from trade are based on comparative advantage not absolute advantage
  
  
  
  

Unit 7 - Mechanics of Foreign Exchange (5-3-16)

Mechanics of Foreign Exchange

• The buying and selling of currency
• Any transactions that occurs in the Balance of Payments necessitates foreign exchanges
• The exchange rate is determined in the foreign currency market

Changes in Exchange Rates

• Exchange rates (e) are a function of the supply and demand for currency
• An increase in supply of a currency will decrease exchange rate of currency
• A decrease in supply of currency will increase exchange rate of a currency
• An increase in demand for a currency will increase the exchange rate of a currency
• A decrease in demand for a currency will decrease the exchange rate of a currency

Appreciation and Depreciation

• Appreciation of a currency occurs when the exchange rate of that currency increases
• Depreciation of a currency occurs when the exchange rate of that currency decreases

Exchange Rate Determinants

• Consumer Tastes
• Relative Income
• Relative Price Level
• Speculation

Exports & Imports

• Exchange rate is a determinant of both exports and imports
• Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper thus reducing exports and increasing imports
• Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports

Floating/Flexible Rates

• Based upon supply and demand of that currency vs other currencies
• Very sensitive to business cycle and provides options for investments

Fixed Rate

• Based on a country's willingness to distribute currency and to control the amount 

Unit 7 - Balance of Payments

• Balance of Payment
• Measure of money inflows and outflows between the united States and the Rest of the World (ROW).
• Inflows are referred to as CREDITS.
• Outflows are referred to as DEBITS.
• The Balance Payments is divided into 3 accounts
• Current Account
• Capital/Financial Account
• Official Reserves Account
• Current Account
• Balance of Trade or Net Exports
• Exports of Goods/Services - Imports of Goods/Services
• Exports create a credit to the balance of payments
• Imports create a debit to the balance of payments
• Net Foreign Income
• Income earned by U.S. owned foreign assets - Income paid to foreign held U.S. assets
• Ex. Interest Payments on U.S. owned Brazilian bonds - Interest payments on German owned U.S. Treasury bonds
• Net Transfers (tend to be unilateral)
• Foreign Aid ---> a debit to the current account
• Ex. Mexican migrant workers send money to family in Mexico
• Capital/Financial Account
• The balance of capital ownership
• Includes the purchase of both real and financial assets
• Direct investment by U.S. firms/individuals in a foreign country are debits to the capital account
• Purchase of foreign financial assets represents a debit to the capital account
• Purchase of domestic financial assets by foreigners represents a credit to the capital account
• Relationship between Current and Capital Account
• The Current Account and Capital Account should zero each other out
• Only if the Current Account has a negative balance (deficit), then the Capital Account should then have a positive balance (surplus)
• Official Reserves
• The foreign currency holdings of the United States Federal Reserve System
• When there is a balance of payments surplus, the Fed accumulates foreign currency and debits the balance of payments
• When there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments
• Where there's a balance of payments the Fed depletes
• Active v. Passive Official Reserves
• The United States is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate

 Formulas

• Balance of Trade: (Goods Exports + Goods Imports)
• Balance on goods and services: (Goods Exports + Service Exports + Goods Imports + Service Imports)
• Current Account: (Balance on goods and services + Net Investment + Net Transfers)
• Capital Account: (Foreign Purchases + Domestic Purchases)

 

Unit 6 - Economic Growth and Productivity

 Economic Growth and Productivity

• Economic Growth Defined
• Sustained increase in Real GDP over time.
• Sustained increase in Real GDP per Capita over time.
• Why Grow?
• Growth leads to greater prosperity for society.
• Lessens the burden of scarcity.
• Increases the general level of well-being.
• Conditions for Growth
• Rule of Law
• Sound Legal and Economic Institutions
• Economic Freedom
• Respect for Private Property
• Political & Economic Stability
• Low Inflationary Expectations
• Willingness to sacrifice current consumption in order to grow
• Saving
• Trade
• Physical Capital
• Tools, machinery, factories, infrastructure
• Physical Capital is the product of investment
• Investment is sensitive to interest rates and expected rates of return.
• It takes capital to make capital.
• Capital must be maintained.
• Technology & Productivity
• Research and development, innovation and invention yield increases in available technology.
• More technology in the hands of workers increases productivity.
• Productivity is output per worker.
• More Productivity = Economic Growth
• Human Capital
• People are a country's most important resource. Therefore human capital must be developed.
• Education
• Economic Freedom
• The right to acquire private property
• Incentives
• Clean Water
• Stable Food Supply
• Access to technology
• Hindrances to Growth
• Economic and Political Instability
• High inflationary expectations
• Absence of the rule of law
• Diminished Private Property Rights
• Negative Incentives
• The welfare state
• Lack of Savings
• Excess current consumption
• Failure to maintain existing capital
• Crowding Out of Investment
• Government deficits and debt increasing long term interest rates
• Increased income inequality ---> Populist policies
• Restriction on Free International Trade

Unit 5 - Suppy Side / Laffer Curve (4-13-16)

Supplyside Economics

• change in AS, not in AD, which determines the level of inflation, unemployment rate and economic growth
• supplyside economists support policies that promote GDP growth by arguing that higher marginal tax rates along with the current system of transfer payments such as unemployment compensation or welfare programs, provide disincentives to work, invest, innovate, and undertake entrepreneurial ventures
• lower marginal tax rates induce more work and AS increases; they also make leisure more expensive and work more attractive

Incentives to Save & Invest

1. High marginal tax rates reduce rewards for savings and investment
2. Consumption might increase, but investments depend on savings
3. Lower marginal tax rates encourage saving and investment

Laffer Curve

• Depicts the relationship between tax rates and government revenues
• As tax rates increase from 0, government revenue increases from 0 to some max level, and then decline
• 3 Criticisms of Laffer Curve

1. Research suggests that the impact of tax rates on incentives to work, save, and to invest are small.
2. Tax cuts increase demand which can fuel inflation and demand may exceed supply.
3. Where the economy is actually located on the curve is difficult to determine.

Unit 5 - Phillips Curve (4-8-16)

Long Run Phillips Curve

• Because the LRPC exists at the natural rate of unemployment (Un), structural changes in the economy that affect Un also cause LRPC to shift
• Increases in Un will shift LRPC --->
• Decreases in Un will shifts LRPC <---

• No tradeoff between inflation and unemployment
• Always vertical at natural rate of unemployment
• Will only shift if LRAS shifts
• Major LRPC assumption is that more worker benefits create higher natural rates, and fewer benefits creates lower natural rates

Short Run Phillips Run

• Short-Run AS SHIFTERS
• Supply Shocks are rapid and significant increases in resource cost, cause SRAS curve to shift
• Outcome: SRAS will decrease <---, SRPC will increase --->
• Misery Index: combination of inflation and unemployment in any given year
• *single digit misery is good*

Inflation: rise in price level

Deflation: general decline in price level

Disinflation: decrease in rate of inflation over time

Stagflation: where inflation and unemployment increase at same time

Unit 5 - Extending (4-7-16)

Short Run Aggregate Supply

• Period in which wages (and other input prices) remain fixed as price level increases or decreases.

Effects over Short-Run

• In short run, price level changes allow for companies to exceed normal outputs and hire more workers because profits are increasing while wages remain constant.
   
• In the long run, wages will adjust to price level and previous output levels will adjust accordingly.

Equilibrium in Extended Model 

• Long AS curve is vertical at FULL EMPLOYMENT

Demand Pull Inflation in AS Model

• Demand Pull: prices increase based on increase in aggregate demand. AD --->
• In the short run, demand pull will drive up prices, and increase production.
• In the long run, increases in AD return to previous levels.

Cost Push

• Cost push arises from factors that increases per unit costs such as increase in price of a key resource
• Short run shifts left 

Dilemma for the Government

• In an effort to fight cost push, the government can react in two different ways
• Actions such as spending by the government could begin an inflationary spiral
• No action however could lead to recession by keeping production and employment levels declining

Unit 4 - Single Banks/Banking System

When a customer deposits cash or withdraws cash from their demand deposit account, it has NO EFFECT ON MONEY SUPPLY.

It only changes:

• The composition of money
• Excess Reserves
• Required Reserves

Single Bank: only loan money from Excess Reserves (ER)

Banking System: (ER * MULTIPLIER)

Total Money Supply

Unit 4 - Expansionary/Contractionary (3-21-16)

3 Tools of Monetary Policy

1) Reserve Requirement: Only a small percent of your bank deposit is in the safe, the rest of your money has been loaned out. This is "Fractional Reserve Banking". The FED sets the amount that banks must hold.

• When the FED increases the money supply it increases the amount of money held in bank deposits.

2) Discount Rate: Interest rate that the FED charges commercial banks
Example: If Bank of America needs $10 million, they borrow it from the U.S. Treasury (which the FED controls), but they must pay it back with interest.

• To INCREASE money supply, the FED should DECREASE the discount rate (expansionary)
• To DECREASE money supply, the FED should INCREASE the discount rate (contractionary) 

3) Open Market Operations: The FED buys/sells government bonds (securities). This is the most important and widely used monetary policy.

• To INCREASE money supply, the FED should BUY securities.
• To DECREASE money supply, the FED should SELL securities.

Federal Fund Rate: where FDIC member banks make overnight loans to other banks
Prime Rate: interest rate that banks charge to their most credit worthy customers

Unit 4 - FED/Multiple Deposit Expansion (3-10-16)

Federal Reserve Bank (FED)

Functions of FED:

• issues paper money
• sets reserve requirements and holds reserves of the bank
• lends money to banks and charges them interest
• they're a check clearing service for banks
• acts as a personal bank for the government
• supervises member banks
• control money supply

Multiple Deposit Expansion

Reserve Requirement: 

• the % of Demand Deposits that must not be loaned out
• usually 10%, no more
• amount set by the FED
• FED requires banks to always have money available for consumer demand for cash

Three Types of Multiple Deposit Expansion Question

1. Calculate initial change in excess reserves (amount a single bank can loan from initial deposit)
2. Calculate the change in loans in banking system
3. Calculate change in money supply 

Unit 4 - Assets & Liabilities (3-9-16)

Financial Sector

1) Financial Assets - stocks or bonds that provide expected future benefits, it benefits the owner only if the issuer of the asset meet certain obligations

2) Financial Liabilities - it is incurred by the issuer of a financial asset to stand behind the issues asset

3) Interest Rate - price paid for the use of a financial asset

4) Stocks - financial assets that convey ownership in a corporation

5) Bonds - promise to pay a certain amount of money plus interest in the future


What Banks Do

• a bank is a financial intermediary
• uses liquid assets (bank deposits) to finance the investments of borrowers
• process known as "fractional reserve banking" = a system in which depository institutions hold liquid assets less than the amount of deposits

Can take the form of
1) Currency in bank vaults
2) Bank reserves - deposits held at federal reserve

T-Account (Balance Sheet): statements of assets and liabilities

Assets: (Amount Owned)

• items to which a bank holds legal claim
• uses of funds by financial intermediaries
• capital stock
• owners equity

Liabilities: (Amount Owed)

• legal claims against a bank 

Unit 4 - Money Demand/Supply/Shifters (3-9-16)

• Demand for money has an inverse relationship between nominal interest rates and quantity of money demanded

1. What happens to quantity demanded of money when interest rates increase?

• Quantity demanded falls because individuals would prefer to have interest assets instead of borrow liabilities 

2. What happens to quantity demanded when interest rates decrease?

• Quantity demanded increases, there is no incentive to convert cash into interest earning assets.

Money Demand Shifters:

1. Changes in price level
2. Changes in income
3. Changes in taxation that affects investment

Money Supply:

• If FED increases money supply, a temporary surplus of money will occur at 5% interest. This surplus will cause interest rate to fall to 2%

How does this affect AD?
Increase money supply --> Decrease interest rate --> Increase investment --> Increase AD

Decrease money supply --> Increase interest rate --> Decrease investment --> Decrease AD

Unit 4 - Time Value of Money (3-9-16)

Is a dollar today worth more than a dollar tomorrow?

• Yes, because opportunity cost and inflation, this is the reason for charging and paying interest.

v = future value of $
p = present value of $
r = real interest rate (nominal - inflation rate)
n = years
k = number of times interest is credited per year

Simple Interest Formula: V = (1 + r)^n * p

Compound Interest Formula: V = (1 + r/k)^nk * p

Example

Assume inflation is expected to be 3% and nominal interest rate on simple interest savings is 1%. Calculate value of $ after  1 year. 

Step 1: Calculate real interest rate. (r% = i% - n%) = (1 - 3 = -2%) OR (-.02)

Step 2: Use simple interest formula to calculate future value of $1
V = (1 + r)^n *p
V = .98 * 1
V = $0.98

Unit 4 - Money (3-4-16)

Money

Uses of money:

• Median of Exchange - to trade
• Unit of Account - establishes economic worth in exchange process
• Store of Value - money holds value for period of time

Types of money:

• Commodity - get its value from type of material from which it was made
• Representative - paper money backed up by something tangible, giving it value
• Fiat - money because government says so. 

Characteristics of money:

• Portable
• Durable
• Scarce
• Divisible
• Acceptable
• Uniform

Money Supply:

• M1 money - (1) cash & coins, (2) check-able deposits/demand deposits, (3) travelers checks)
• M2 money - consists of M1 money, savings accounts, market accounts, and deposits held by banks outside the U.S., not as liquid to convert
• M3 money - consists of M2 money and certificates of deposits held by private institutions

Monetary Policy Video Problem III

https://youtu.be/73Kj2huWnOM

Unit 4 - Money & Banking / Monetary Policy (3-21-16 - 3-27-16)

Unit 4 Video Summaries

Unit 4 Part 1: Types/Functions of $

There are three types of money, they are commodity, representative, and fiat money. Commodity money is money that can be used and is available. Representative money represents the quantity of a precious metal. Fiat money doesn't represent anything but the promise that the government says it has value. There are three functions of money. First is as a median of exchange (trade), second as a store of value(savings), and a unit of account(quality).

Unit 4 Part 3: Money Market
The money market graph is labeled interest on the y-axis, and labeled quantity of money on the x-axis. The money demand is always downward sloping, and is tied into the interest rate. The money supply is fixed and is set by the FED, meaning it only moves if told to move. When demand increases, it puts pressure on interest rates. If the FED wants to bring the rate back down, they increase the money supply.

Unit 4 Part 4: Tools of Monetary Policy
In regards to the tools of monetary policy, the FED uses expansionary, also known as easy money, and contractionary policies, also known as tight money. In the expansionary policy, the reserve requirement decreases. The lower the money in RR, it makes the incentive for the banks to be irresponsible with money. On the contractionary policy, the reserve requirement increases. Also for the expansionary policy, the discount rate goes down, but increases for the contractionary policy. Easy money policy buys bonds, and tight money policy sells bonds. The FOMC makes all decisions.

Unit 4 Part 7: Loanable Funds
The demand for loanable funds is always downward sloping. The y-axis is labeled interest, and the x-axis is labeled quantity of loanable funds. The supply is loanable funds is dependent on savings, meaning the more money people save, the more banks have to loan out. If there's an incentive to save more, the supply of loanable funds increases, shifting right. If there's a deficit, the government is demanding more in order to spend it.

Unit 4 Part 8: Money Creation Process
Banks make money by making loans. If the reserve requirement is 20%, and the loan amount is $500, how much $ is created? To find that, you must find the money multiplier by (1/RR). So, (1/0,2) = 5. Once you find the multiplier, you multiply that by the loan amount, which is $500. $500 multiplied by 5 is $2500, which is the answer to the problem. When the bank keeps loaning out money, the total amount of loanable funds will be $2500.

Unit 4 Part 9: Money Market, Loanable Funds, AS/AD
The money market, loanable funds, and as/ad graphs are all connection with one another. When the money demand increases, interest rate increases as well as AD. There a rightward shift that goes along for all three graphs.The fisher effect connects the increase in interest rates with the increase in price level.

Unit 3 - Fiscal Policy, Automatic Stabiliziers, Tax System (2-29-16)

Fiscal Policy: changes in the expenditures or tax revenues of the federal government

2 Tools of Fiscal Policy

• Taxes: government can increase or decrease taxes
• Spending: government can increase or decrease spending

Deficits, Surpluses, and Debt

Balanced Budget: Revenue = Expenditures
Budget Deficit: Revenues < Expenditures
Budget Surplus: Revenues > Expenditures
Government Debt: (Sum of all deficits - Sum of all surpluses)

Government must borrow money when it runs a budget deficit
They must borrow from:

• Individuals
• Financial Institutions
• Corporations
• Foreign entities or foreign government

Fiscal Policy Two Options

1) Discretionary Fiscal Policy (action)

• Expansionary Fiscal Policy - think deficit. Combats recession, increase government spending, decreases taxes.
• Contractionary Fiscal Policy - think surplus. Combats inflation, decrease government spending, increases taxes.

2) Non-discretionary Fiscal Policy (no action)

Discretionary vs. Automatic Fiscal Policies

Discretionary: increasing or decreasing government spending and/or taxes in order to return the economy to full employment. Discrestionary policy involves policy makers doing fiscal policy in response to economic problem.

Automatic: unemployment compensation and marginal tax rates are examples of automatic policies that help mitigate effects of recession and inflation. Automatic fiscal policy takes place without policy makers having to respond to current economic problems.

 Automatic or Built-in Stabilizers

• anything that increases governments budget deficit during a recession and increases its budget surplus during inflation without requiring explicit action by policymakers.

Economic Importance:

• taxes reduce spending and aggregate demand
• reductions in spending are desirable when the economy is moving toward inflation
• increases in spending are desirable when economy is heading toward recession

Examples: 

• Medicare
• Medicaid
• Social Security
• Unemployment

 Tax System

Progressive Tax System:

• Average tax rate (Tax revenue / GDP) rises with GDP

Proportional Tax System:

• Average tax rate remains constant as GDP changes

 Regressive Tax System:

• Average tax rate falls with GDP

Unit 3 - Classical vs. Keynesian (2-24-16)

CLASSICAL vs. KEYNESIAN

Modern Followers:

Classical:

• Adam Smith
• J.B. Say
• David Ricardo
• Alfred Marshall

Keynesian:

• Jim Keynes

Say's Law:

Classical:

• supply creates its own demand
• production = income = spending
• under spending is UNLIKELY

Keynesian:

• depressions refute Say's law
• demand creates its own supply
• under spending PERSISTS

Savings and Investments:

Classical:

• savings (leakage)  = investment (injection) income

Keynesian:

• savings NOT = investment
• future needs (precaution, habit, income level, interest rate)
• interest rate (rate of profit, expectations)

Loanable Funds Market:

Classical:

Keynesian:

• investment from savings, cash, and checking accounts
• lending creates money = money supply increases
• inflation and unemployment are unstable

Wage/Price Flexibility:

Classical: prices and wages are flexible downward
Keynesian: prices and wages are inflexible downward (ratchet effect)

Supply Curve:

Classical: vertical
Keynesian: horizontal

Output and Employment:

Classical: AS determines output and employment
Keynesian: AD determines output and employment

Unemployment:

(S = Savings, I = Investment)
Classical:

• cause: external (war)
• rarely exists due to wage price flexibility

Keynesian:

• usually exists
• cause: external (war), internal (S not equal to I)

Aggregate Demand:

Classical:

• AD determines price level 
• AD is reasonably stable if money supply is stable

Keynesian:

• AD changes due to the determinants
• AD is unstable even if money supply is stable due to fluctuations in investments

Basic Equation:

Classical: (MV = PQ)
Keynesian: (C + Ig + G + Xn)

Role of Government:

Classical:

• monetary rule maintain a steady money supply
• believes laissez faire is best
• economy is self-regulated

Keynesian:

• fiscal policy
• active government
• economy is not self-regulated

Inflation:

Classical: caused by too much money
Keynesian: caused by too much demand

How long the short run is:

Classical: short time
Keynesian: very long time

Emphasis today:

Classical: Micro-eco
Keynesian: Macro-eco

Classical:

• competition is good
• believe in invisible hand
• in long run, economy will balance at full employment
• economy is always close to or at full employment
• believe in triple down effect.

Keynesian: 

• competition is flaud
• AD is key, not AS
• leaks and savings cause recessions 
• in long run, we're all dead
• believe sticky wages block say's law

Unit 3 - Consumption & Saving, Spending & Tax Multiplier (2-25-16)

Disposable Income (DI): income after taxes or net income. (DI = Gross Income - Taxes)

2 Choices:
With disposable income, households can either:

1. Consume (spend $ on goods & services)
2. Save (not spend $ on goods & services)

Consumption

• Household spending

Ability to consume is constrained by: 

• The amount of disposable income
• The propensity to save

Do households consume if DI = 0?

• Autonomous consumption
• Dissaving

Saving

• Household NOT spending

The ability to save is constrained by:

• The amount of disposable income
• The propensity to consume

Do households save if DI = 0?

• NO

APC & APS

Average Propensity to Consume

Average Propensity to Save

• APC + APS = 1
• 1 - APC = APS
• 1 - APS = APC
• APC > 1 = DISSAVING
• -APS = DISSAVING

Marginal Propensity to Consume (MPC)

• Fraction of any change in disposable income that is consumed
• MPC = (Δ in Consumption / Δ in Disposable Income)

Marginal Propensity to Save (MPS)

• Fraction of any change in disposable income saved
• MPS = (Δ in Savings / Δ in Disposable Income)

MPC + MPS = 1

MPC = 1 - MPS

MPS = 1 - MPC

Spending Muliplier Effect

An initial change in spending (C, Ig, G, Xn) causes a larger change in aggregate spending or aggregate demand.

• Multiplier = (Δ in AD / Δ in spending (C, Ig, G, or Xn)

Calculating the Spending Multiplier

• Multiplier = (1 / 1 - MPC) or (1 / MPS)
• Multipliers are postive(+) when there is an increase in spending and negative(-) when there's a decrease

Calculating the Tax Multiplier

When the government taxes, the multiplier works in reverse.

WHY?

• Because now money is leaving the circular flow

Tax Multiplier (note: It's NEGATIVE)

• (-MPC / 1 - MPC) or (-MPC /  MPS)
• If there's a tax cut, then multiplier is positive(+), because there's more money in the circular flow

Unit 3 - Nominal, Real, and Sticky Wages, & Investment Demand (2-22-16)

Nominal Wages vs. Real Wages

Nominal: amount of $ received by a worker per unit of time. Ex:) Paid by hour, by day, etc.

Real: amount of goods and services a worker can purchase with their nominal wages.

Sticky Wages

Sticky: where your nominal wage level is set according to an initial price level, and does not vary due to labor contracts or other restrictions.

What is investment?

Money spent or expeditures on:

• New plants (factories)
• Capital equipment (machinery)
• Technology (hardware and software)
• New homes
• Inventories (goods sold by producers)

Expected Rates of Return

1) How does business make investment decisions?

• Cost/Benefit analysis

2) How Does business determine the benefits?

• Expected rate of return

3) How does business count the cost?

• Interest costs

4) How does business determine the amount of investment they undertake?

-Compare expected rate of return to interest cost

• If expected return > interest cost, then invest
• If expected return < interest cost, then do not invest

Real (r%) v. Nominal (i%)

Whats the difference?

• Nominal is the observable rate of interest. Real subtracts out inflation (π%) and is only known ex post facto

How do you compute the real interest rate (r%)

• r% = i% - π%

What determines the cost of an investment decision

• The real interest rate (r%)

Shifts in Investment Demand (ID)

1) Cost of production

• Lower costs shift ID --->
• Higher costs shift ID <---

2) Business Taxes

• Lower business taxes shift ID --->
• Higher business taxes shift ID <---

3) Technological Change

• New technology shifts ID --->
• Lack of technology shifts ID <---

4) Stock of Capital

• If an economy is low on capital, then ID --->
• If economy has much, then ID <---

5) Expectations

• Positive expectations shifts ID --->
• Negative expectations shifts ID <---

Unit 3 - LRAS and SRAS (2-19-16)

Full Employment

FULL EMPLOYMENT equilibrium exists where AD intersects SRAS & LRAS at the same point.

Recessionary Gap

Inflationary Gap

An INFLATIONARY GAP exists when equilibrium occurs BEYOND full employment output

Unit 3 - Aggregate Supply (2-18-16)

Aggregate Supply: the level of real GDP that firms will produce at each price level

Long-Run vs. Short-Run

Long:

• Period of time where input prices are completely flexible and adjust to changes in the price-level
• In the long-run, the level of REAL GDP supplied is independent of price-level

Short:

• Period of time where input prices are sticky and do not adjust to changes in the price-level (hard to shift)
• In short-run, level of REAL GDP supplied is directly related to price level

Long Run Aggregate Supply (LRAS):

• LRAS marks the level of full employment in the economy. (analogous to PPC)
• Because input prices are completely flexible in the long-run, changes in price-level do not change firms' real profits and therefore do not change firms' level of output. This means that the LRAS is vertical at the economy's level of full employment

Changes in Short-Run Aggregate Supply (SRAS):

• An INCREASE in SRAS in seen as a shift to the RIGHT --->
• A DECREASE in SRAS is seen as a shift to the left <---

SRAS is per unit cost of production.
Per Unit Production Cost = (Total Input Cost / Total Output)

Determinants of SRAS 

• Input prices
• Productivity
• Legal-Institutional Environment

Input:

1) Domestic Resource Prices

• Wages (75% of all business costs)
• Cost of capital
• Raw Materials (commodity prices)

2) Foreign Resource Prices
3) Market Power
4) Increase in Resource Prices = SRAS <---
5) Decreases in Resource Prices = SRAS --->

Productivity:

= (Total Output / Total Input )

• more productivity = lower unit production cost = SRAS --->
• lower productivity = higher unit production cost = SRAS <---

Legal Institutional Environment:

Taxes & Subsidies

• Taxes ($ to Gov.) on business increase per unit production cost = SRAS <---
• Subsidies ($ from Gov.) to business reduce per unit production cost = SRAS-->

Unit 3 - Aggregate Demand (2-12-16)

Aggregate Demand: the demand by consumers, business, government, and foreign countries.

What definitely doesn't shift the curve?

•  Changes in price level cause a move along the curve.

Why is AD downward Sloping?

1) Real-Balance Effect

• Higher price levels reduce purchasing power of money, this decreases the quantity of expenditures
• Lower price levels increase purchasing power and increase expenditures
• Ex:) If balance in your bank was $50,000, but inflation erodes purchasing power, you'll likely reduce your spending

2) Interest-Rate Effect

• When price level increases, lenders need to charge higher interest rates to get a real return on their bang
• Higher interests rates discourage consumer spending and business investment

3) Foreign Trade Effect

• When U.S. price level rises, foreign buyers purchase fewer U.S. goods and Americans buy more foreign goods
• Exports fall and imports rise causing real GDP demanded to fall. (Xn decreases)
• Ex:) If prices triple in the U.S., Canada will no longer buy U.S. goods, causing quantity demanded of U.S. products to fall

Shifters of AD

• GDP = C + Ig + G + Xn
• There are TWO parts to a shift in AD

1. A change in C, Ig, G, and/or Xn
2. A multiplier effect that produces a greater change than the original change in the 4 components

INCREASE in AD = AD --->
DECREASE in AD = AD <--- 

 Determinants of AD

1) Consumption

Consumer Wealth

• more wealth = more spending (AD shifts --->)
• less wealth = less spending (AD shifts <---)

Consumer Expectations

• positive expectations = more spending (AD shifts --->)
• negative expectations = less spending (AD shifts <---)

Household Indebtness

• less debt = more spending (AD shifts --->)
• more debt = less spending (AD shifts <---)

Taxes

• less taxes = more spending (AD shifts --->)
• more taxes = less spending (AD shifts <---)

2) Gross Private Investment

Real Interest Rate

• lower real interest rate = more investment (AD shifts --->)
• higher real interest rate = less investment (AD shifts <---)

Expected Returns

• higher expected returns = more investment (AD shifts --->)
• lower expected returns = less investment (AD shifts <---)

Expected Returns are influenced by:

• expectations of future profitability
• technology
• degree of excess capacity
• business taxes

 3) Government Spending

• more government spending (AD shifts --->)
• less government spending (AD shifts <---)

 4) Net Exports

Exchange Rates (International value of $)

• strong $ = more imports and fewer exports (AD shifts <---)
• weak $ = fewer imports and more exports (AD shifts --->)

Relative Income

• strong foreign economies = more exports (AD shifts --->)
• weak foreign economies = less exports (AD shifts <---)

Unit 2 - Inflation & Unemployment Rate (2-2-16 to 2-5-16)

Real Interest Rate: percentage increase in purchasing power the borrower must pay the lender for a loan.
Formula = (Nominal Rate - Inflation)

Nominal Interest Rate: percentage in crease in money the borrower must pay the lender for a loan.
Formula = (Expected interest rate + inflation premium)

Who's hurt by inflation?

• savers
• lenders/creditors
• those on fixed income (elderly, welfare, social security, medicaid)

Who gains from inflation?

• Borrowers
• Those locked into contracts

COLA: cost of living adjustments, (gives automatic wage increases when inflation occurs)

Unemployment

Unemployment: failure to use available resources particularly labor, to produce desired goods and services.

Labor Force: 

• Above 16 years old
• Able and willing to work

NOT in Labor Force:

• Military
• Mental Institutions
• In jail or prison
• Retired
• Students
• Homemakers
• Not looking for job

Unemployment Rate: 4 to 5% = FULL EMPLOYMENT or NATURAL RATE OF UNEMPLOMENT (NRU)

Calculate Unemployment Rate: (# of unemployed / # of employed + # of unemployed) * 100

Types of Unemployment

1. Frictional:

• searching for a job
• temporarily unemployed
• in between jobs
• transferable skills
• someone leaving job for a better job,

      2. Structural:

• changes in structure of the labor force make some skills obsolete
• workers don't have transferable skills

      3. Seasonal:

• due to the time of the year and nature of the job
• (lifeguards, school bus drivers, construction workers)

      4. Cyclical:

• unemployment that results from economic downturns (recession)
• as demand for goods and services fall, demand for labor falls and workers are laid off

Unit 2 - GDP, Real/Nominal GDP, GDP Deflator, Inflation (1-28-16 to 2-1-16)

GDP

GDP: total market value of all final goods and services produced in a country's borders within a given year.

GNP: total market value of all final goods and services by citizens of that country of if its land or foreign land,

Included in GDP:

• 65% (C) - "Personal Consumption Expenditures"
• 17% (Ig) - "Gross Private Domestic Investment" (Factory Equipment/Maintenance, Construction of houses, unsold inventory of products built in a year)
• 20% (G) - "Government Spending"
• -2% (Xn) - "Net Exports (exports - imports)

NOT Included in GDP:

1. Intermediate Goods - good requires further processing before ready for final use.
2. Used/Secondhand Goods - avoid double counting.
3. Purely Financial Transactions - (stocks) its not physical.
4. Illegal Activity - drugs
5. Unreported Business Activity - tips
6. Transfer Payments - (Public: Social Security), (Private: Scholarships)
7. Non Market Activity - volunteering, babysitting, work for oneself

2 Ways of Calculating GDP (Expenditure vs. Income Approach)

1) Expenditure Approach: add up all spending on final goods and services produced in a given year. (GDP = C + Ig + G +Xn)

2) Income Approach: add up all of the income that resulted from selling all final goods and services produced in a given year. (GDP = (W)Wages, (R)Rent, (I)Interest, (P)Profit)

Nominal and Real GDP

Nominal: value of output produced in current prices

Real: value of output produced in constant base-year prices

(Formula = Price * Quantity)

• nominal can increase from year to year if either output of price increases
• real GDP can increase from year to year ONLY if output increases
• if you want to measure economic growth, use REAL GDP
• if you want to measure price increases, use NOMINAL GDP
• REAL GDP is adjusted for inflation (Uses BASE YEAR)
• Base Year = Earliest year if not given.

FORMULAS

NDP/Net Domestic Product: (GDP - Depreciation)

NNP/Net National Product: (GNP - Depreciation)

GNP: (GDP + Net Foreign Factor Payment)

GDP Deflator & Inflation

GDP Deflator: price index used to adjust from nominal to real GDP 
Formula = (Nominal / Real GDP) * 100

• in base year, deflator will always = 100
• in years AFTER base year, GDP is GREATER than 100
• in years BEFORE base year, GDP is LESSER than 100

Consumer Price Index (CPI): most commonly used measurement of inflation 
Formula = (Price of market basket in particular year / Price of same market in BASE year) * 100

Inflation: (GDP deflator in NEW or Current Year - GDP deflator in OLD Year / GDP deflator in OLD Year) * 100

Unit 2 - Circular Flow (1-25-16 to 1-27-16)

Circular Flow

There are 2 markets, the Factor and Product market.

In the Factor market:

• Firms buy
• Households sell

In the Product market: 

• Firms sell
• Households buy

Firms:

• buy resources
• sell products

Households:

• sell resources
• buy products

Unit 1 - Business Cycles (1-21-16)

BUSINESS CYCLES

Peak: highest point of real GDP

• lowest unemployment
• greatest spending

Expansion: where real GDP is increasing

• causes spending to increase
• unemployment decreases

Contraction/Recession: where real GDP declines for 6 months

• increased unemployment
• reduction in spending

Trough: lowest point of real GDP

• highest unemployment
• least spending

Unit 1 - Supply and Demand (1-19-16 to 1-20-16)

TABLES

Fixed Cost: a cost that does not change no matter how much is produced

• Rent, Mortgage, Insurance, Salary

Variable Cost: cost that rises or falls depending upon how much is produced

• Electricity

Marginal Cost: cost of producing one more unit of a good

• New total rev - Old total rev

FORMULAS

TC = TFC + TVC
ATC = AFC + AVC
AFC = TFC / Q
AVC = TVC / Q
ATC = TC / Q
TFC = AFC * Q
TVC = AVC * Q

(EXAMPLE of a table BELOW)

Equilibrium is the point at where the supply curve and the demand curve meet. This is where all resources are being efficiently used.

Excess Demand: when the quantity demanded is greater than the quantity supplied. This will result in SHORTAGES, where consumers cannot get the quantities of items that they desire.

Price ceiling creates a shortage.  A price ceiling occurs when the government puts a legal limit on how high the price of a product can be.  In order for a price ceiling to be effective, it must be set below equilibrium. 

Excess Supply: when the quantity supplied is greater than he quantity demanded.  This will result in a SURPLUS, where producers have inventories they cannot get rid of.

Price floor is the lowest legal price a commodity can be sold at. A price floor creates a surplus.  Price floors are used by the government to prevent prices from being too low. The most common price floor is the minimum wage.

Unit 1 - Supply and Demand (1-11-16 to 1-15-16)

Demand and Supply

Demand: quantities that people are willing and able to buy at various prices
"What causes a Δ in quantity demanded?" = Δ in PRICE

What causes a "Δ in demand"?

1. Δ in buyers taste (advertisement)
2. Δ in the # of buyers (population)
3. Δ in the price of related goods 

• Complementary = Car and Gas
• Substitute = Soda/Tea/Juice

      4. Δ in income

• Normal = as peoples income rises, demands for goods and services also rise
• Inferior = increase in income causes fall in demand

      5. Δ in expectations

Supply: quantities that producers or sellers are willing and able to produce at various prices
"What causes a Δ in quantity supplied?" = Δ in PRICE

What causes a "Δ in supply"?

1. Δ in weather (natural disaster, drought)
2. Δ in # of sellers
3. Δ in cost of production
4. Δ in technology
5. Δ in expectations
6. Δ in taxes or subsidies

Elasticity of Demand

• measure of how consumers react in Δ in price

Elastic Demand: demand that is very sensitive in Δ in price

• E>1
• product is NOT a necessity; there are substitutes
• ex.) Soda, Steaks, Candy, Fur Coats

Inelastic Demand: demand NOT SENSITIVE in Δ in price.

• E<1
• product is a necessity; few to no substitutes
• people will buy no matter what
• ex.) Gas, Salt, Insulin/Medication, Milk

Unitary Elastic Demand:

• E=1

Price Elasticity of Demand (PED)

Step 1: Quantity

• (New Quantity - Old Quantity) / Old Quantity = QUANTITY

Step 2: Price

• (New Price - Old Price) / Old Price = PRICE

Step 3: PED

• (% Δ in quantity demanded) / (% Δ in price) = PED

Unit 1 - Scarcity, Factors of Production, Production Possibilities Graph (1-5-16 to 1-8-16)

Macroeconomics vs. Microeconomics

Macro: study of the economy as a whole

• supply and demand
• international trade
• minimum wage 

Micro: study of individual or specific units of the economy

• market structures 
• business organizations 

Positive Economics vs. Normative Economics 

Positive: attempts to describe the world as is, very descriptive, collects and presents FACTS

Normative: attempts to prescribe how the world should be. OPINIONS

• "ought to be"
• "should be"

Needs vs. Wants

Needs: Basics requirement of survival

• water, food, shelter, clothing

Wants: Desire of citizens

• cars, candy, computers, cell phones

Goods vs. Services

Goods: Tangible commodities

• bought, sold, or produced 

1. Capital Goods: items used in the creation of other goods (trucks, factory machines) 
2. Consumer Goods: intended for final use by the consumer

Services: work that is performed for someone

• haircut, concert, school

Scarcity vs. Shortage

Scarcity: Most fundamental economic problem facing all societies; how to satisfy UNLIMITED wants with LIMITED resources. Always involves a choice.

Shortage: Quantity demanded is greater than quantity supplied

Factors of Production

1. Land: natural resources
2. Labor: work force
3. Capital: human and physical

• Human = skills(college, training). where did you get those skills?
• Physical = tools, machines, buildings

      4. Entrepreneurship: innovated, risk-taker, owning a business

Production Possibilities Curve/Graph (PPC/PPG)

Trade-offs: alternative that we give up when we choose one course of action over another
Opportunity-cost: next best alternative
Efficientcy: using resources in such a way as to maximize production of goods and services
Allocative Efficiency: products being produced are the ones that are most desired by society
Productive Efficiency: products being produced in the least costly way. (any point on the production possibility curve)
Underutilization: using fewer resources than an economy is capable of using

Production Possibilities Curve: shows alternative ways to use economy's resources
   (4) Assumptions:

1. Two goods
2. Fixed resources
3. Fixed technology
4. Full employment of resources

3 Types of Movement Occur within PPC

Inside PPC: resources unemployed, resources underemployed, and/or productive efficientcy. attainable, INEFFICIENT
Along PPC: attainable, but EFFICIENT
Shifts of the PPC: when resources and technology change

 

What causes the PPC/PPG to shift?

1. technology change
2. change in resources
3. change in labor force
4. economic growth
5. national disasters/war/famine
6. more education or training