ap macroeconomics notes
DESCRIPTION
Notes made for high schoolers taking AP Macroeconomics. Made in an easy-to-understand format, sure to get you a high score on the AP test.TRANSCRIPT
UNIT 1--- Goods vs. Service-- A “good” is something that is tangible that satisfies people's’ wants and desires.-- A “service” is something that is intangible that satisfies people’s wants and desires.--- Economics Defined-- “Economics is the study of how individuals and society, experiencing virtually limitless wants,
chooses to allocate its scarce resources to satisfy those wants.”-- Something is scarce if there is a limited amount of it and it is valuable.- If something isn’t valuable, then it won’t be missed, if it doesn’t have a value, then there won’t be
a reason to create it/buy it.
--- RESOURCES ARE LIMITED!-- There is a constant struggle between our unlimited wants and our limited resources.-- Whenever our unlimited wants are going after the limited resources available, there is always acost.
-- NOTHING IS FREE. *Cost doesn’t have to be money*
--- OPPORTUNITY COST-- The cost is NOT always a monetary cost.
- This cost can be a social cost, an emotional cost a jealously cost or any number of costs that are
out there.
-- In economics, we call these costs, opportunity costs.- The opportunity cost is the next best alternative.- Bryan has four things he can do:
- Watch a movie, party, study, or go bowling.
- Bryan chooses to go bowling, the opportunity cost is the next best thing, so his opportunity costis his PERSONAL one, not the same as someone else may think.
- The trade-off is everything EXCEPT for his choice, so watching a movie, party, AND studying.
--- Economics simplified
Scarcity
Choices
Opportunity Cost
--- Resources-- Four basic categories of scarce resources are:
1). Land ( Natural resources)
-- Land is a scarce resource because it is valuable (water, air, and raw materials, etc. are all requires
to produce things) and there is a limited amount of it
- Take these and make a product out of them
2). Labor (Human resources/capital)
-- It’s scarce because only a limited amount of people are available to work.
- In the U.S, only those aged 16+ are considered part of the labor force (employed or unemployed)
3). Capital
-- In economics, capital does NOT mean money!
-- Capital means man-made goods that produce goods for future consumption
- A physical item used in the production process such as equipment, machinery, factory4). Entrepreneurship
-- An individual who is willing to take the risk to start a business.
--- Production Possibilities Curve
-- What is PPC?
- It illustrates the possible combinations of goods or services that can be produced by a single
nation, firm, or individual. (Self-explanatory)
- X and Y axis can be interchanged only on this graph
-- What does it show?
- That nothing is free and that everything has an opportunity cost. If society wants more guns, it
must give up butter.
-- What basic economic concepts can it be used to model?
- Scarcity, tradeoffs, opportunity cost, economic growth, efficiency, unemployed resources.
-- Understanding the PPC.- Either 25 guns, or 50 units of butter, or something in between
- A point inside the PPC is attainable but not desirable. A point outside the PPC is desirable yet
unattainable.
-- Assumptions about the PPC- The PPC frontier is attainable only if a nation achieves full-employment of its productive
resources.
- The nation’s resources are fixed in quantity.
- The nation’s technology is fixed.
- An increase in productive resources (like the two above) will shift the graph to the right;;decrease will shift it to the left.- Assumes that the nation must choose between only two goods.
- The economy is closed, i.e. does not trade with other nations.
- Represents only one country’s economy.
--- Which point(s) are attainable and desirable?*A, B, and C*-- Tells us we are at full employment (between 4 and 6%);; U.S is at 7.9%- Represent an efficient use of Bedrock’s resources
--- Which point(s) are attainable but not desirable?*D*-- Shows us inefficient use of resources, high unemployment rate.
--- Which points are unattainable yet desirable?*E*-- Not enough resources.
--- Which point will mean more consumption in the future?- Point A represents more consumption in the future, because guns represent capital goods, which
are used to make other products for consumption.
--- Which point will mean more consumption now?- Point C because butter represent consumer goods. Households do not normally buy and use guns
(capital goods), but they do like butter (consumer goods).
Absolute Advantage- Particular individual or county can produce more of a specific commodity than another countryComparative Advantage- Particular individual or country can produce a specific commodity at a lower opportunity costthan another individual or country.- DETERMINES HOW NATIONS SPECIALIZE.- Specialization results in more efficient production- The country that can produce something at a lower opportunity cost should produce it-- If there is no comparative advantage, there is no incentive to trade
--- The Law of Demand-- If the price of a good rises, the quantity demanded of that good decreases;; and if the price of agood falls the quantity demanded of that good increases.-- A change in quantity demanded is a movement along the demand curve- Can only happen as a result of change in price.
-- Elements of DemandWhy an inverse relationship between price and quantity?
Diminishing marginal utility one burrito, seven bucks second burrito, here’s already full! it’s not worth seven bucks!
Income effect nothing to do with how much money you make, it’s your purchasing power as price goes up, we just can’t buy as much with the same amount of money as price goes down, obviously you can buy more
Substitution effect price of cocaine goes up, you’ll buy more XTC price of coke goes up, you’ll buy more pepsi
Common sense
-- A change in demand is a shift in the demand curve.- At every price, we’re purchasing more items.- We don’t buy more because the price changes, we just buy more because our demand haschanged.
-- What’s going to change demand? (What causes a shift in the demand curve?)(Non-price determinants of demand) TIMER
1. Change in consumer tastes and preferencesa. Anything that changes our purchasing habits.b. i.e: salmonella found in Jiffy Peanut Butter, so demand curve shifts to the left!
c. i.e: advertising campaign has Beyoncé in it, we love her!2. Changes in market size
a. Bigger the market, bigger the demandb. McDonald’s opens restaurants in China, more demand because there are simply
more peoplec. Put B-Killz on the internet, he’ll sell more music
3. Change in consumer incomesa. Our incomes go up, demand goes up or vice a versab. Inferior good - as your income goes up, the demand for that product goes down
i. in college, I’m lovin that ramen noodle diet;; but after I become aprofessional kickboxer, and I’m makin a ton of money, my taste for ramennoodles goes down
4. Changes in prices of related goodsa. Complementary goods - goods that are often purchased together
i. If the price of hamburgers goes up, our demand for hamburger buns goesDOWN.
ii. Price of hamburgers going up affects the quantity of demand of hamburgers,which then changes the demand for buns.
b. Substitute goods - goods that can be substituted for one anotheri. As the price of Coke goes up, the quantity demanded of Coke goes down.ii. Demand for Pepsi goes up.
5. Changes in consumer expectationsa. Future income - if we think our future income will go up, our future demand goes
up today;; if we think our future income is going to go down, we’re going to holdoff purchasing goods and services
Future prices - the price of gasoline is supposed to go up tomorrow, so we increase ourdemand for goods today;; if price of gasoline is gonna go down, then we will hold offtoday, and buy tomorrow
--- Supply vs Demand-- Supply is harder than demand, because nobody is used to supplying, but rather buying shit
--- The Law of Supply- If the price of a good rises, the quantity supplied of that good increases;; and if the price of agood falls the quantity supplied of that good decreases.
- Profit motive -- if we sell it a higher price, we make more of a profit- A change in price leads to a change in quantity supplied! That’s a movement along the curve.- SAME THING AS DEMAND.
-- 6 things that shift the price curve (supply shifters)-- Called the Non-price determinants of supply (ITGONE)- Rule: Anything that increases the cost of production, decreases the supply, and vice versa.
1). Changes in the price of inputs- Raw materials, labor, price of oil (transportation)
2). Changes in technology- Introduction of technology lowers the production cost
3). Government tools1. Taxes - If gov. increases the tax on business, profits go down, so does supply2. Subsidies - Government gives us money to lower (defray) production cost, profits go up,
so does supply3. Regulations - costs business money, increases cost of production (work for 4
hours=break, certain age for work, minimum wage);; taking away regulations increases supply ofproduct).4). Changes in the price of other goods
- If you’re making more money off of pizza, you’re going to lower the supply of calzones5). Changes in the number of suppliers
- If there’s only one pizza shop it’s the only supplier, if more pizza shops open, more pizzascan be supplied6). Changes in producer expectations
- Future prices: You can go either way, increasing and decreasing supply.
- Anything that increases the cost of production decreases supply!
- Anything that decreases the cost of production increases supply!
--- Market equilibrium
-- Exists where market demand equals market supply.
-- Surplus: quantity supplied is greater than quantity demanded- The market price is greater than the equilibrium price
- In a free market, when there is a surplus, the price will move down, trying to reach equilibrium.
-- Shortage: quantity demanded is greater than quantity supplied- The market price is less than the equilibrium price
- In a free market, when there is a shortage, the price will move up, trying to reach equilibrium.
2 Types of Government Regulation:1). Price Floors: the government sets a market price, and you can’t go below it, this creates aSURPLUS, since the government is setting a price ABOVE the equilibrium price
- Minimum wage has created a surplus of teenage workers
2). Price Ceilings: you can’t go above the government set price, creates a shortage since thegovernment is setting a price BELOW the equilibrium price
- Rent control creates shortage
Unit 2
Quantity Price
Year Units Price/unit Price Index Nom. GDP
1984 7,000 $10.00 62.5 70000
2000 2200 $16.00 100 352,000
Quantity x Price = Nominal GDP (gross domestic product)
Price Index -- sort of like a GDP deflator, makes two years in our nation equal to each other interms of monetary value- (Current cost / base cost) x 100 = Price Index(10/16) x 100 = 62.5
What % did the price level rise from 1984-2000?Calculate any kind of change : (Price index in latest year - Price index of earlier year)/Price indexof earlier year x 100100 - 62.5 = .60 or 60% 62.5
Calculate real GDP:
1). Take nominal GDP, divide it by price index in hundredths.2). Units of output multiplied by the price per unit (in base year).For 1984, 7,000 x 16.00=112,000
GDP is a statistic to help us determine if our economy is healthy or not
- GDP: The total market value of all final goods and services produced within a country in a givenyear
What does this mean??- “Total market value”
- The price of a good or service at the time it is sold multiplied by the number produced- Ex: If an economy only made staplers, and they were priced at $5 and made 100 staplers,
then the GDP would be $500- “Final goods and services”
- The intended end condition of the good or service. Eliminates counting of intermediategoods.
- Intermediate goods are goods that go into account for making the final good- Don’t count pieces and parts separately
- “Produced within a country”
-- The goods and services included in GDP must have been produced within the borders ofthe U.S (or whatever fuckin country you’re speakin of)- “In a given year”
- GDP is a monetary measure - it has a dollar value (BIG TIME BENJAMINSSSSS)
LOCATION IS SO FUCKING IMPORTANT!!!
- GDP DOES INCLUDE the market value of goods and services produced by American ownedbusinesses located in the U.S. or by foreigners who own a business located in the U.S.
- Honda is Japanese, but produces in Ohio -- Those products are part of American GDP- General Motors is American, but cars it produces in Mexico do not count in US GDP
Expenditures Approach:1). Personal Consumption Expenditures (C) (65-70% of GDP)
- Things that households purchase:1. Durable consumer goods (designed to last greater than 3 years)2. Non-durable consumer goods3. Consumer expenditures for services
2). Gross Private Domestic Investment (I) (50% of GDP and it is volatile)- Things that businesses buy1. Machinery, equipment and tools2. All construction3. Changes in business inventories4. Non-investment transactions (Capital goods)
3). Government purchases (G) (20% of GDP)- Government spends more money during recessions to compensate for businesses and
consumers not being able to spend as much money1. Expenditures for goods and services2. Social capital expenditures3. Excludes government transfer payments (social security welfare etc.)
4). Net Exports (Xn) (Exports - Imports)- We import more shit than we export, so our net export is negative
GDP = C + I + G + (Exports - Imports)
So, now your goofy ass may ask, what’s not included in GDP???????????Excludes:1). Financial Transactions
- Public transfer payments- Welfare- Unemployment compensation
- Private transfer payments- Birthday money (money from grammy)
- Stock market transactions- Nothing new is being produced, so it’s not counted in GDP
2). Secondhand sales- Plato’s Closet
- Used cars3). Underground economy
- Black market items (fake Chinese iPads)- Illegal drugs (such as heroin, cocaine, cupcakes)
- Weed’s gotta be reported in legal states. The happy places.- Household production- Other illegal activities- Leisure time
4). Intermediate goods
--- SIMPLE CIRCULAR FLOW (Morton Workbook pg. 63)-- Simple circular flow doesn’t include government-- It includes product market because it is the buying and selling of goods/services-- It includes factor/resource market because it is the buying and selling of factors of production
- Young people participate because they can sell their factor of production, LABOR, tosome firm
- Every two weeks you receive: wages, rent, interest or profit in return for your factor ofproduction- Only two things you can do with your income: save it or spend
- When you save money, it doesn’t help the economy grow when you look at the circularflow
- When you use the money, you contribute to the economy (business firms)- The business firm will then use that money to pay the wages, rent, interest, or profit,
which will be used to make more goods/services, AND THE FUCKING CIRCLE OF LIFECONTINUES AHHHH ZAAMEETANA WAABBAA WWWEEB SEE BOB BOB- OHS IS GOVERNMENT
- They buy computers, desks, etc. and thus are involved in the product market- Also produces factors of production, and thus is involved in the factor/resource market
--- Inflation
- It’s a rise in the general level of prices.
Anticipated inflation - we know it’s gonna happen, built into our economic decisionsUnanticipated inflation - the level of inflation that is not expected or unforeseen
Advantages (people helped) Disadvantages (people hurt)
-- Wages increase therefore governmentreceipts increase
-- Businesses raise price prior to raising wages
-- Debtors (borrowers) gain because they haveuse of money now, when its purchasing poweris greater
-- People on fixed income tax lose purchasingpower
-- Creditors
UNEMPLOYMENT
--- Employed
- Everyone currently working- Includes part time workers- Noninstitutionalized civilian population 16 and over- Work in family business, 15 hours or more per week - no pay-- Does not include those working under the table or in the underground economy
---Unemployed
- Do not meet requirements of employed- Must be looking for work in the last 4 weeks
- Applying for jobs, putting resumes out there- Temporarily laid off from work- Current unemployment rate is 7.8%
---Key definitions
-- Labor Force: Employed + unemployed ( not including underground economy)-- Labor Force population rate: - a proportion of the population over 16 years who are looking forwork or are working
- Calculated by dividing the labor force by the population over the age of 16-- Unemployment rate - Unemployed divided by the labor force
--- An increase in the labor force participation rate shifts the PPC curve outward...a decrease shiftsthe PPC inward
-- PPC curve changes because of factor of production or factor of technology
--- Problems with unemployment rate-- It’s just a statistic-- Doesn’t include
1). Marginally attached workers: people who once held productive jobs but have givenup looking for work
2). Discouraged workers: no longer have the required skills3). Underemployed workers = part-time jobs, someone who has a full time job below
their skills set
---We want our unemployment rate to be between 4-5% and 4-6%
---Types of Unemployment1). Frictional unemployment (this is why we will never get to zero)
- When workers are moving from one job to another- New entrants to the labor force- Re entrants to the labor force- Normal part of a healthy economy
2). Structural unemployment- Occurs as a result of changes in technology or the way the economy is structured- Going from agricultural economy to industrial- Normal part of a healthy economy
3). Seasonal unemployment- Unemployment tied to the seasons of the year or holidays- Snowplow drivers, cocaine dealers who only sell during Thanksgiving (my friend Jared)
4).Cyclical unemployment- Results from recessions and economic downturns- Follows the business cycle- More harmful than any other type of unemployment
REMEMBER THIS POINT: the natural rate of unemployment is where there is no cyclicalunemployment!!! WHICH we like to call FULL EMPLOYMENT
Unit 3- Personal savings (S)- Consumption (C)- Disposable Income (DI)
- For people, it’s the money we earned after taxes- For the government, it’s the GDP
- DI = C+S- Average Propensity to Consume (APC) = C/DI- Average Propensity to Save (APS)= S/DI
- APC + APS MUST = 1- MPC = Change in C/ Change in DI- MPS = Change in S/ Change in DI- MPC + MPS = 1--- Consumption Graph-- Production (Disposable income-GDP) = X-axis, Consumption = Y-axis-- Consumption equals disposable income anywhere on the 45 degree line-- Don’t forget that the major determinant of consumption and savings is Disposable Income
-- Things that shift consumption line:
-- Non-income Determinants of Consumption and Savings:- Wealth - the value of my assets: houses, cars, stocks and bonds- If our perceived wealth goes up, then we will buy stuff, thus our consumption will go up- Expectations - if prices are going to go down in the future, we will save now, and spend
later- Real Interest rates - the cost of getting a loan, or higher the cost of getting money- RIRs are the marginal cost of borrowing money- if RIR goes up, we are going to spend
less- Household debt - as we borrow more money, our debt goes up;; as our household debt
goes up, consumption goes up saving goes down until we reach a certain point- Taxation - with taxation, consumption and savings will move in the same direction
because any increase in taxes is partly paid for out of future consumption and our savings accounts-- Multiplier effect - change in initial spending will have a ripple throughout the economy, creating a larger change in GDP
- Spending multiplier = 1/MPS
- Change in spending x Multiplier = Change in GDP
--- Investment spending- Investment decisions are a marginal cost vs marginal benefit decision- Marginal cost - interest rate paid to borrow funds (i)- Marginal benefit - expected rate of return (r)
-- Things that shift investment demand curve:
- Costs - increase in costs, cuts into profit, while decrease in costs makes me more profitable
- Business taxes - inverse variation- Technological changes - if price to produce goes down, profit goes up- Stock of capital goods on hand - if no factories are empty, then I might build a new
factory- Expectations - expectations of future income, if your income should go up, you will save
--- Keynesian Model- Real GDP is on the x-axis (it’s what’s produced), the aggregate expenditures is on the y-axis (it’s what is consumed)- Y = income or RGDP- Equilibrium does not have to be at full employment (between 4-5% and 4-6%);; just because we’re at equilibrium doesn’t mean that we are at full employment
Aggregate Demand & Aggregate Supply
PL = Inflation rate (price level), on the y-axisRGDP = output, nations income, on the x-axisY = incomeYf = full-employment income
-- Aggregate Demand- The sum of all expenditures in the economy over a period of timeAD = C + G + I + Xn-- Aggregate Demand Curve- Shows the overall level of spending at different price levels- Note: Inflation or price level used for the vertical (Y) axis- U = unemployment rate
- A rise in the price level causes a lower level of aggregate demand, TRA LA LAA.- Any increase in interest rates (inflation) will raise the cost of borrowing:
- Consumption spending will fall (durables)- Business investment will fall- International competitiveness will decrease - exports fall, imports rise. (Xn gets smaller)
- When the US prices level increases relative to foreign prices -- foreigners buy fewer US goods, and Americans buy more foreign goods
- A rightward shift in the AD curve will result in an increase in RGDP and lead to a fall in unemployment.
- If we shift the curve right--- SO WHAT CAUSES A FUCKING SHIFT IN THE CURVE??-- AD = C + I + G + Xn (any change in these fuckers will change the overall graph)- C - Consumption Expenditures
- Exogenous factors affecting consumption- Tax rates- Income - short term and expected future income- Wage increases (wages can change)- Credit availability;; cost of borrowing- Interest rates;; cost of borrowing- Wealth
- Property- Shares of stock- Savings- Bonds
- I - Factors of investment- Spending on: Machinery, Equipment, Buildings, Infrastrcuture- Influenced by: Expected rates of return (expectations, technology, excess capacity, taxes), Interest
rates (money supply)--(How much will it cost me to borrow this money?), Expectations of future sales, Expectations of future inflation rates- G - State, local, and federal spending- Influenced by: political environment, income (tax revenue)- Xn
- Import spending reduces aggregate demand (represents outflow of funds from the US, employment goes down)
- Export earnings - inflow- KEY VARIABLESNATIONAL INCOME ABROAD-Rising income abroad encourages foreigners to buy more goods, some of which might be
US goods- If our country is in inflation, our imports would go down, and thus other countries’
exports would go downEXCHANGE RATES- As dollar depreciates against foreign currencies US made products become less expensive
to foreign countries (our exports would go up)
-- Aggregate Supply mother fucker- Yf is always at the x-axis of ANY curve
- Level of real domestic output that firms will produce at each price level.- Production responses differ in the long run, when nominal wages and other resource prices match changes in the price level- In the long run, inflation goes up your nominal wages should go up as well, to balance each other- LRAS Curve:- As inflation goes up, production is at the same point
- Now, you may be stupid and think why does this happen, but because it’s in the long run, as inflation rate goes, the price of the goods I sell go up, and the price of production goes up as
well as everything else (they all cancel each other out)
- In the long run as the rate of inflation increases wages increases too. Thereby offsetting
any change in production.
- Any change in economy that alters the natural rate of output (PPC curve) shifts the long-run
aggregate-supply curve. (labor, resources, capital, technology)
- SRAS Curve- In the short run, an increase in the overall level of prices in the economy tends to raise the
quantity of goods and services supplied.
- WHY THE FUCK IS THE AS’S CURVE SLOPE POSITIVE!??!?!- In the short run, an increase in the overall level of prices in the economy tends to raise the
quantity of goods and services supplied.
- A decrease in the price level tends to reduce the quantity of goods and services supplied.
-- Sticky Wage Theory- Nominal wages are slow to adjust, or are “sticky” in the short run: Wages do not adjust
immediately to a fall in the price level, due to wage control, and shit like that.- This means that in the short term, they won’t change
--- Self-Correction Theory of the Economy- However in the short term, real wages will change depending on inflation;; if inflation is high,
then real wages will go down
- IF there’s high inflation, in the long term, “his” nominal wages will go up, because he will go to
his boss and ask for more money;; after he asks for money, and hopefully receives it, the cost of
production will go up, shifting the SRAS to the left
- Nominal wages are flexible in the long run, because as we transition from short term to long term,
new salaries, new performance reviews, new union contracts all become factors of wages
--- Fiscal PolicyDiscretionary Fiscal Policy- Deliberate (discretionary) manipulation of taxes and government spending by Congress
- Purpose is to alter real GDP, employment, inflation, and economic growth
- Assumes:
- Initial government purchases don’t suppress or stimulate private spending
- Fiscal policy only affect demand side of the economy-- Expansionary Fiscal Policy - used to combat a recessionTools/Weapons:
1). Increase government spending
2). Reduce taxes (less effective b/c part of the tax money will be saved, not spent)
- That’s why the tax multiplier is one less than the opposite of the spending multiplier
3). Combination of the two
- Often leads to a government budget deficit (deficit spending)- Two ways to finance deficit spending:
1). Borrow money
- Government demand for funds (loans) could lead to higher interest rates -- choking off
investment spending and consumer durable spending (Crowding out)
2). Make more money
- Creation of new money is more expansionary, but can lead to higher levels of inflation-- Contractionary Fiscal Policy - used to combat an inflationTools/weapons:
1). Decrease government spending
2). Increase taxes (less effective)
3). Combination of the two
- Often leads to a government budget surplus (revenues greater than spending)
- Disposing of Contractionary Policy surplus:
1). Debt reduction
- Using the surplus to pay off debt may reduce the anti-inflationary impact of the surplus
- By increasing the supply of loanable funds in the market -- interest rates may fall
2). Impounding
- Allowing the surplus to stand idle
- Government is then withholding purchasing power from the economy
-- Supply Side Fiscal Policy- Emphasis on expansionary tax cuts- Tax reductions will shift the SRAS to the right, negating inflation and increasing output- Impact on:
- increase of savings and investment
- increasing capital stock
- incentive to work, to take new jobs
- increasing productivity
- risk taking bitchhheezz
Non-discretionary Fiscal Policy- Built-in automatic stabilizers
- Designed to temper the effects of business cycle swings- Anything that increases the government’s budget deficit during a recession and increases it’s
surplus during inflationary periods
- Transfer Payments
- people will either spend or save;; the transfer payments are used during a recession
(esp. welfare)
- Progressive tax system- simply, as income goes up, percent taxed goes up, and vice a versa- tiered tax system tailored to each person’s income
- Regressive tax system- puts burden on the poor, because higher percent taxed because of a lower income
- A recession can be defined as a low rate of GDP growth (less that 2%), or a high unemployment rate (greater than 6%)- A high inflation rate is greater than 4%
--- Born from the Great DepressionProblems of timing:
- Recognition lag - how long does it take for the government to realize we’re in inflation or recession (took about 12 months in 2008 to recognize it)
- Administration lag - how long does it take Congress to act on it, either with expansionary or contractionary fiscal policy
- Operational lag - how long does it take the implemented policy to affect the economy (the 2008 stimulus package still isn’t in full effect!)
-- Criticisms- Political Business Cycle- Crowding Out effect (THIS SHIT IMPORTANT)
- The government borrows to finance deficit- This can raise real interest rates- Choking off Investment spending and consumer durable good purchases- AD eventually actually ends up decreasing, when the purpose of the expansionary policy
was to initially increase
Fiscal Policy Complications- Shocks from abroad- Net export effect
Unit 4
Equation of Exchange
MV = PQ
- M is the money supply
- V is the velocity of money, that is, the average number of times per year a dollar is spent on finalgoods and services- P is the price level or the average price each unit of output is sold- Q is the physical volume of all goods and services produced- MV represents total amount spent by purchasers- PQ represents the total amount received by sellers (nominal GDP)
- The velocity of money has increased over the course of timeMoney supply:M1= most liquid;; (currency+coins)+demand deposits+checkable deposits+traveler’s checksM2= less liquid;; M1+(savings+small-time deposits <100k)+money market deposit accounts+noninstitutional money market mutual funds+short-term money market assets
The Demand for MoneyTransaction demand for money - derives from medium of exchange
- Nominal interest doesn’t affect it, Nominal GDP affects it, price level affects it- As GDP and price level increase, the transaction demand will shift right (the demand for
money will shift to right)Asset demand - derives from money’s function as a store of value
- Demand to hold money- We do it, to save it for later, the money in our piggy bank or in our mattress is much more
liquid than money in the bank- Varies inversely with the interest rate -- as interest rate goes up, I’m not going to hold cash
- “An increase in the interest rate increases the opportunity cost of holding moneyand reduces the quantity of money demanded.”
- If the bank is going to give me a higher interest rate, i.e more money than I hadbefore, WHY THE FUCK WOULD I KEEP IT IN MY PIGGY BANK?!?!? I LOVE MONEY,SO I WANT TO MAKE AS MUCH AS POSSIBLE SO I CAN SPEND IT ON HOOKERSAND BOOZE AND DRUGS!Total Money Demand = Transaction demand for money + asset demand for money
- Total amount of money that public wants to hold at each interest rate- As nominal GDP changes the total money demand curve shifts (due to transaction
demand)- PL increase will shift total demand curve to the right- As RGDP increases demand for money will increase as we purchase more goods and
services- Technology (ATM’s, credit cards, debit cards, paypal, etc) reduces the need to hold
moneyThe Money Market = Total demand for money + supply of money
- Supply of money is held constant -- IT WILL NOT CHANGE UNLESS WE CHANGEIT!
- Supply of money is set by the U.S. Federal Reserve (as part of their monetary policy)- Intersection of the supply and demand curves determines the equilibrium nominal
interest rate
- As the demand for money increases/decreases, the nominal interest rateincreases/decreases -- if the supply of money increases/decreases the nominal interest rate willdecrease/increase, RESPECTIVELY
Sm
NIRQ Dm
- International money does two things (international investments, financial assets, investing ingoods and services)International investors:
- Chase less expensive goods- Chase high interest rates -- when interest rates go up, our dollar will appreciate in value
- This is because they will get more money back, this will eventually increase thevalue of the United States dollar, which means that our imports will go up, decreasing our netexports
How Banks Create Money
Fractional Reserves: Only a fraction of the total money supply is held in reserve ascurrency
- Enables banks to make loans that are not fully backed by reserves- Federal Reserve sets the reserve requirement- banks are then required to hold reserves in
the mother truckin fed or their own vault
Reserve Requirement: Banks deposits are subject to a reserve requirement, other shit iscalled EXCESS RESERVES, they can loan that shit out and buy hookers. Reserves are designedto provide the Fed with Control over the overall money supply. Banks make loans with their
EXCESS reserves. Banks create money by lending their EXCESS reserves.
How banks create money: The amount that a bank is allowed to lend is determined by theRequired Reserve Rate (RRR). The RRR is the percent of deposits that banks are required to keep
in reserve. FOR example. If Ben deposits $1,000 in the bank and the RRR is 20%, then the bank
must keep $200, and can loan out $800. The Fed determines the RRR.
Money multiplier: 1/RRR:
The increase in the money supply equals...initial cash deposit multiplied by 1/RRR
Suppose the RRR is 20%. A $5 million cash deposit will create as much as $20 million.
1/.2=5(money multiplier) 5x$5 million=$25 million, then subtract $5 million (because it’s already
in the money supply), and get $20 million. Unless the direction say otherwise, any deposit of
money is new money.
Janet Smith deposits $1000 of her cash holdings in her checking account at First Federal
Bank. The reserve requirement is 20% and the banks has no excess reserves.
A) What is the immediate effect of her deposit on the money supply? Explain why.
No change, because the money supply neither increases or decreases when she
deposits the cash into the bank, because cash is already part of the money supply.
B) What is the maximum amount of money First Federal can initially loan out. Explain
how you determined this.
$1000 x 20% = $200 (required reserves) $1000 - $200 = $800
$800, because that’s their excess reserves.
C) What is the maximum amount of money the entire banking system can create? Explain.
1/.2= 5 x 1000= 5000 - 1000 = $4000. You take the initial deposit x the multiplier,
to get the money supply, and then
D) Give one reason why the money supply may not increase by the amount you identified
in C).
Because the bank refuses to give all the loans.
The consumers refuse to take on loans.
If the person receives the check, they spend it, instead of putting it into another
bank.
Tools of Monetary Policy
Open Market OperationsBuying securities from
Commercial banks or the public
Increases the money supply by increasing bank excess reserves
Selling securities toCommercial banks or the public
Decreases the money supply by decreasing bank excess reservesOpen Market Transactions:
Buying Securities:
1. Fed buys $1000 bond from a commercial bank2. Increase in bank reserves of $10003. Total impact to money supply -- $1000 x 5 = $5000 increase
Selling Securities
1. Fed sells $1000 bond to a commercial bank2. Decrease in bank reserves of $10003. Total impact = 5000
Reserve Requirement Ratio
Raising the Reserve ratioBanks must hold more required reservesBanks hold fewer excess reservesBanks decrease lendingDecreases the size of the money multiplierMoney supply decreases
Lowering the Reserve rationBanks hold more excess reservesMoney supply increase
The Discount Rate - The interest rate that the Fed charges on loans they make to commercialbanks.
Lowering the discount rate encourages commercial banks to obtain additional reserves byborrowing from the Fed
Increasing the discount rate discourages commercial banks from obtaining additionalreserves- Fed raises the discount rate when it wants to restrict the money supply- Fed lowers the discount rate when it wants to expand the money supply (lower the cost ofborrowing giving the banking system an incentive to borrow from them--however most banksdon’t like to borrow money from the Fed, because it’s like borrowing from the boss...they’ll asktoo many questions)HIGH INFLATION=OVER 4% INFLATION;; HIGH UNEMPLOYMENT=OVER 6%Cause-Effect Chain
Money supply impacts interest ratesInterest rates affect investment spendingInvestment spending is a component of aggregate demand (AD)Equilibrium GDP changes
Easy Money Policy - (expansionary) To increase the supply of money, the Fed must increase theexcess reserves of commercial banks by
Buying securities (open market transactions)
Lower the reserve ratio
Lower the discount rate
Useful in fighting high unemployment and recession.- Measure inflation by using CPI
Effectiveness of Monetary PolicyStrengths
Speed and flexibility
Not touched by political pressure
History
Weaknesses
Control
Velocity
Cyclical Asymmetry - when commercial banks will not lend out their excess reserves or
when consumers refuse to take on new loans
Tight Money Policy - (contractionary) To decrease the supply of money, the Fed must decreasethe amount of excess reserves of commercial banks.
Selling securities (open market transactions)
Increasing the reserve ratio
Raising the discount rate
Useful in fighting high inflation. Jews.
Fed Funds Rate - Interest rate that member banks charge one another on overnight loans ofreserves
- Rate is established by the fucking interaction of lenders and borrowers
Supply and demand of excess reserves
- When the Fed reduces bank reserves the Fed funds rate will increase (vice versa)
Selling securities
Reduces excess reserves
Decreases supply of excess reserves increase the Fed funds rate
Net Export Effect
Problem: Recession Problem: Inflation
Easy money policy (lowers interest rates)Decreased foreign demand for dollarsDollar depreciatesNet exports increase (aggregate demandincreases, strengthening the easy moneypolicy)
Tight money policy (raises interest rates)Increased foreign demand for dollarsDollar appreciatesNet exports decrease (aggregate demanddecreases, strengthening the tight moneypolicy)
During a 1984 Presidential debate President Reagan boasted that his administration hadsuccessfully lowered interest rates. While his opponent, Walter Mondale, stated that interest rateswere at their highest point in decades. Who was correct?
1980 1984
Nominal Interest Rate 11.5% 9.6%
Inflation rate 9.2% 3.7%
Real Interest Rate 2.3% 5.9%
They were both right, they were just talking about different interest rates. Walter Mondale said thatthe real interest rate is too high and Reagan was talking about lowering the nominal interest rate.
- NOMINAL INTEREST RATES
- Rate of interest expressed in dollars of current value.- Rate of interest published in the newspaper (market rate)- Nominal rates increase/decrease to account for anticipated inflation- Nominal rates (short-term rates) are determined the money market
If there’s a question about short term rates, you have to use the money marketLong term rates are the real rate
- REAL INTEREST RATES
- The nominal interest rate less the anticipated rate of inflation (ir = in = anticipated rate ofinflation)
- Adjusted for the effect of inflation- If inflation is positive then the real interest rate will be lower than the nominal interest rate- If inflation is negative (deflation) then the real interest rate will be higher than the
nominal interest rate.- The real interest rate is of importance in investment decisions because it measures the real
cost of borrowing money.- Real interest rates are determined in the loanable funds market.
UNIT 5
Unemployment and the business cycle
The percentage difference between the actual level of real gdp and potential output is the output
gap.
- When actual output is equal to potential output, the actual unemployment rate is equal to the
natural rate of unemployment.
Inflationary gap means the output gap is positive (higher actual output than potential output).Recessionary gap is negative (high unemployment rate).
- The expected rate of inflation is the rate of inflation that employers and workers expect in the near
future.
- SRPC shifts up the same amount as an increase in expected inflation.
- On the SRPC the expectations of inflations can differ from the actual inflation rate.
The long-run Phillips curve shows the relationship between unemployment and inflation afterexpectations of inflation have had time to adjust.
Supply Factors
-- Increase in Quantity/Quality of NATURAL resources-- ***Increase in Quantity/Quality of HUMAN resources
Quality- Education/training (human capital)
- Motivation- Work environment- Health
- SkillsQuantity
- Immigration
- Re-training- Labor force participation
- If we improve these HUMAN factors, productivity increases, making real income increase, andthus AD increase as well as SRAS-- ***Increase in Quantity/Quality of TECHNOLOGY
- Increases productivity, and thus real income will increase and so AD will shift right aswell as SRAS!-- ***Increase in Quantity/Quality of CAPITAL RESOURCES (will be on test)
- Increases productivity, and thus real income will increase and so AD will shift right aswell as SRAS!
- **The interest rates will determine how much money is actually invested, because it’s thecost of borrowing-- ***Efficiency- Productive efficiency = producing the most amount of goods/services with the least usage ofresources- Allocative efficiency = use your factors of production efficiently to produce goods/services thatare in demand (the desirable goods) MAKE ALL THE HOES HAPPY
Money Market Model - short run interest ratesd
Loanable Funds Model --- view this link:
http://www.edmodo.com/file/view-crocodoc-new-window?uuid=4af8ff31-61cf-4a42-9aa2-ec7
b6d88ae5d&file_id=62461000
- Model of the real interest rate determinationThe real interest rate is called the long run interest rate
The supply of credit represents the activities of lendersIntersection is the REAL INTEREST RATE
The demand for credit represents the activities of borrowers
Factors that affect demand Factors that affect supply
- Rising Interest Rates (-)- U.S budget deficits (+)- Inflationary expectations (-/+)
- Rising interest rates (+)- Consumer savings rates (+)- Business savings rates (+)- Mandatory savings (+)- Fed reserve credit creation (+)- Foreign purchase of US financial assets (+)- Inflationary expectations (+)
When the govt borrows money to finance budget deficits, this increases the demand for loanablefunds! If we increase the demand of loanable funds, the real interest rate goes up, and investmentspending goes down. Govt borrowing blocks out private investment by raising the price ofinvestment.
Economic Theories
Keynes - manipulate economy by shifting AD- you should use fiscal or monetary policy to stabilize the economy- manipulates the economy- wages sticky in short term- demand is unstable due to investment spending
- thus we manipulate the economy through fiscal or monetary policy- if we manipulate the money supply, interest rates will change, the cost of borrowing changes, and thus the investment spending changes, and so AD would shift
Classical (old) - economy self corrects, b/c wages/resources will change depending on state of economy.- economy is self-correcting, so no action is necessary (takes 2-3 years)- wages/resource prices are flexible (supply can go up or down)- AD is stable as long as the MS is constant- AS in classical economic theory is vertical
Rational Expectations (RET) - change from short term to long term is instantaneous- Expected changes in AD have no effect on output, only on price level (true in old)- Stable in long run at NRU- That people have expectations of higher inflation, if they think that inflation is higher, then they adjust their habits of consuming, prior to the price level changing- So if I thought the price level was going up, I would ask for higher wages, and thus the economy would correct itself before the problem even happens
Monetarism- MV = PQ- velocity is stable- economy is stable unless there’s inappropriate monetary policy
- to compensate for that, they have monetary rules- for each increase in output or aggregate demand, they have to increase the price
level by the same amount- a change in money supply impacts AD directly
- if people have more money, they are going to spend more money- monetarists believe interest rates are ineffectual
Supply side (Reaganomics)- Shifting the supply curve rather than shifting demand- targeted tax cuts to job creators and employers
because:
- increase of savings and investment
- increasing capital stock
- incentive to work, to take new jobs
- increasing productivity
- risk taking bitchhheezz
UNIT 6International trade enables nations to specialize their production, enhance their resource
productivity and acquire more goods and services.
The comparative advantage for working in a factory in China is a lot lower than in the US
Why the fuck do nations trade?- The distribution of resources among nations is uneven
- Efficient production of goods and requires different technologies or combinations of resources
- As a result some countries can produce goods and services more efficiently than others
International Trade- Productivity is what makes us rich
- Specialization is what makes us productive
- Trade allows us to specialize
Absolute AdvantageWhere one country can produce goods with fewer resources than another country
Comparative AdvantageWhere one country can produce goods at a lower opportunity cost - it sacrifices less resources
during production
So now you may ask yourself, why the frickin frack aren’t shirts being made in Seattle?- I’m sayin’ because Seattle is a shitty ass place
- It’s actually because production costs are higher in the US than in taiwan or Venezuela
- We, the US citizens, have much better opportunities than working as dress shirt
manufacturers
web
A O
US 75 150
Father Israel 100 300
Comparative advantage in production of dildos- US, opportunity cost: 1 a=2 o
Comparative advantage in production of vibrators- Father Israel, opportunity cost: 1 a= 3 o
If US has comparative advantage in production of aks, then Father Israel automatically has
comparative advantage in production of o's.
Terms of Trade - both companies benefit.-for this, 3 a for 1 o.
Before Trade
A O
US 75 150
Father Israel 100 300
After Trade
A O
US 50 75
Father Israel 25 325
International TradeTrade BarriersEffects of Trade Protection
- An economy has free trade when the govt does not attempt either to reduce or to increase the
levels of exports and imports that occur naturally as a result of supply and demand
- Policies that limit imports are known as trade protection or simply as protection- Tariffs = tax on imports
- Import quotas = limiting how many imports come into a country
- Subsidies = when the govt provides you with money to defray some production cost, the US govt
subsidizes the oil industry in the US, to defray the cost of oil exploration
Effects of a Tariff
- Tariff = tax on imports
- Raises domestic price above world/international price, leading to a fall in trade and total
consumption and a rise in domestic production
Who gains? Who loses?
- Domestic producers and government gain, b/c the domestic producers get help to compete
internationally, the govt gains by getting higher tax revenue
- CONSUMERS LOSE b/c if the people who make the goods out of “sugar”, then either the
prices of our sugary products will increase, or the size of them will decrease if they remain the
same
Tariff Graph
Q1 - domestic production w/out tradeQ2 - total production w/tradeQ3 - domestic production with trade
- I might lose my job if my employer/factory can’t produce a lot and get a lot of profits- And then I will complain to my congressmen
Q4 - domestic production with tariffsEffects of an Import Quota- Import quota is a legal quantity limit on imports- Its effect is like that of a tariff, except that revenues-quota rents- accrue to the producer, NOT to the govt- THE GOVT. DOESN’T GAIN FROM A QUOTASurplus/subsidies- Supply increases- As supply increases, price decreases- Thus consumers benefit from a subsidy
The Political Economy of Trade Protection
Arguments for Trade ProtectionAdvocates of tariffs and import quotas offer a variety of arguments.Three common arguments:
- national security - if we lose our steel, we can’t build weapons- job creation - factories create jobs- the infant industry argument - we want to nurture this industry, like a wee liddle lad, until he got his sea legs under ‘is feet YAR
- Current Account -- Exports and imports- Net investment income = US earnings on investment abroad minus foreign earnings from capital invested in the US- Net transfers = giving money to our relatives in Soviet Russia, or our relatives in Soviet Russia send money to US- Financial Account - buying and selling of real assets and financial assets- Real asset = a house, land, building, something that doesn’t go away, something that you cannot physically pick up and move from one country to another country- Financial asset - stocks and bondsAny time we increase foreign exchange in our country, it’s credit, any decrease is debit
If we buy imports, it’s a debit, or a negative
If there is a surplus in the current account, there should be a deficit in the financial account, so basically the two accounts should be in balance- If you increase the quantity demanded of one country’s currency, you increase the supply of the other country’s currency
Reffonomics
A. A US investor buys Australian govt. bonds for 100k.- Flow of money is out = debit
Exchange Rates
Suppose that the Germans really enjoy Californian wine. How would they pay for this wine?
They would have to exchange their Euros for US dollars, so they’re demanding US dollars in the foreign exchange market. So to demand these US dollars, they have to increase their Euro supply. This is known as currency depreciation.Germans must purchase US dollars to purchase American goods.
This increase in demand for dollars leads to a shift in the demand for dollars. As the demand for dollars increases, the price of the dollars increases. This increase in the price of dollars is known as currency appreciation.
WHAT ARE THE MAJOR THINGS THAT MAKE CURRENCY EXCHANGE RATES CHANGE IN VALUE?Determinants of Exchange Rates
Changes in tastesRelative income changes - this means that if the US is in an expansionary phase, and Europe is in a recession, that means that people in the US are buying goods and services from Europes, so our imports would go up, the supply of the dollar would go up, and the demand of the Euro would go upRelative price level changes - that’s inflation. If prices are high in Mexico, and low in the United
States, we are going to buy from our goods in the United StatesRelative interest rates - for foreign exchange, interest rates are the rate of return. I’m an international investor, and I can invest anywhere I want, so I am going to put my investments in the higher interest rate country, because I will get more money back.Speculation - I think that the US dollar will appreciate vs the yen, so they will buy US dollars for the future. If I had some kind of knowledge of what the Federal Reserve was doing to interest rates in the US vs another country.
6 Graphs that errbody needa knowPPC AD-AS
Money Market Loanable Funds
Phillips Curve Foreign Exchange
Formulas:
RGDP (in terms of spending) C+I+G+Xn
NGDP Quantitycurrent year x Pricecurrent year
Price index is also the GDP deflator (current year cost/base year cost) x 100
RGDP (NGDP)/CPI (hundredths)ORCurrent periodoutput x Base periodprices
GDP Growth Rate ((Current RGDP - PreviousRGDP)/Previous RGDP ) x 100
Inflation rate ((Current CPI - PreviousCPI)/Previous CPI) x 100
Real interest rate Nominal Interest Rate - Inflation
Unemployment rate # of people unemployed/# of peoplein labor force
Money multiplier 1/RRR
Equation of exchange MV=PQ
MPC + MPSAPC + APS
11
Spending multiplier 1/MPS
Tax multiplier -MPC/MPS or -MPC/(1-MPC)
Change in spending x Spendingmultiplier
Change in GDP
Economic What to produce How to produce For whom to F.O.P
System it produce
Command GOVT GOVT GOVT GOVT
Market peeps peeps peeps peeps
Economic Systems:1. Command2. MarketThere is no pure command or pure market economy.Three questions that every economy has to answer:1. What to produce?2. How to produce it?3. And for whom to produce.
How to change money supply in the money market graphEasy money policyFed buys bondsThey can lower the discount rateLower the reserve requirement
Tight money policyFed sells bondsRaise the discount rateRaise the reserve requirement
How to change money demand in the money market graph1. Transaction demand - demand for money in your pocket to buy goods/services, i.e. pocketmoney
- GDP changes it, because if there is an increase in GDP, we need more money to buy ourgoods/services;; if GDP goes up, demand for money goes up
- As PL goes up, demand for money goes up, b/c we need more money to pay for the moreexpensive services2. Asset demand - why do we hold money as an asset? to save it for later idiot
- Our asset demand for money is the demand that we have to save up the money- As the interest rate rises, we don’t keep our money, because the rate of return increases,
and thus we can get more money, and thus deposit it into the bank;; as interest rate goes down,people are more likely to not deposit it, and rather keep it in a drawer upstairs
- If asset demand goes down, then demand for money goes up