A) Chapter 1: Foundations of Economics i) There are five foundations of economics: incentives, trade-offs, opportunity cost, marginal

thinking, and the principle that trade creates value b) What is Economics?

i) Economics is based on the principle that scarcity exists ii) Economics is the study of how to allocate our resources given the scarcity

c) What are the five foundations?i) Incentives: factors that motivate to act or exert effort

(1) two paired categories of incentives: positive – negative and direct – indirect (a) positive incentive example: end of year bonuses to motivate hard work(b) negative incentive example: speeding tickets(c) direct incentive example: Unemployment benefits alleviate suffering caused by

unemployment(d) indirect incentive example: receiver of unemployment benefits decide to stay on

unemployment rather than go to work (2) incentives are needed to drive innovation: patents and copyright laws incentivize

investors to take the cost of research and developmentii) Trade – Offs

(1) Doing one thing often means that you will not have resources to do something elseiii) Opportunity Cost: the highest valued alternative that must be sacrificed in order to get

something else. Ex: cost of going to concert = lost opportunity of going hiking (1) Everyone looks to minimize opportunity cost by selecting the option with highest

benefit(2) Largest benefit = lowest opportunity cost

iv) Marginal Thinking(1) Economic thinking involves choosing between doing more or less of something rather

choose whether or not to do something(2) Marginal Thinking: to evaluate the benefit of one more unit of something is greater than

its cost if the Marginal Cost < Marginal Benefit, then you would do thatv) Trade Creates Value

(1) Trade: the voluntary exchange of goods and services between two or more parties (2) Trade creates further growth because of the ability to specialize (3) Comparative advantage: the situation where an individual, business or country can

produce at a lower opportunity cost than a competitor does(a) Specialization at the micro level: physicians, teachers, plumbers, etc. (b) Specialization at the macro level: high skill labor intensive vs. low skill labor

intensive countriesd) Chapter 1: Summary

i) Incentives matter, trade – offs exist when we decide, each time a choice is made we experience an opportunity cost, marginal thinking requires weighting extra benefits against extra costs, trade creates value because participants can specialize in the production of goods and services that they have a comparative advantage

B) Chapter 2: Model Building and Gains from Trade i) A positive statement can be tested and validated “what is?”ii) Normative statement cannot be tested or validated “what ought to be?”iii) We use models to simplify reality; should be understandable, flexible and foreseeable iv) Ceteris paribus: the concept meaning “other things being equal”v) Endogenous factors: the variables that be controlled for in a model vi) Exogenous factors: the variables that cannot be controlled for within a model vii) when building models beware of faulty assumptions which would lead to policy failures

b) What is Production Possibilities Frontier?i) PPF serves as a model that illustrates the combinations of outputs that a society can

produce if all of its resources are being used efficientlyii) If there is a constant trade – off between two things, the curve would be linear not

always the case because some resources are better equipped to produce one type of good iii) The bowed PPF reflects the increasing opportunity cost of productioniv) Law of increasing relative cost: the opportunity cost of producing a good rises as a society

produces more of it c) What are the Benefits of Trade?

i) Being relative good at something / producing somethingii) Absolute advantage: is when one producer is better than all other producers and produces

more with same resources iii) Comparative advantage: ability to make a good at a lower cost than another produceriv) To determine the lowest cost for producing a pizza or wing: get the price for each person

that is lower than the opportunity cost of producing that goodv) Consumer goods: produced for present consumptionvi) Capital goods: produce other valuable goods and services in the futurevii) Investment: the process of using resources to create or buy new capital

(1) The more that is invested in capital, the larger the expansion of the PPF in the futureC) Chapter 3: Supply and Demand

a) What are the different types of markets?i) Market economy: allocates resources among households and firms with little to no

government influence ii) Prices are used to allocate those resources and for exchanges to take place. Markets are

established with prices and the prices change depending on the level of demand and supplyiii) Competitive markets are ones in which there are so many buyers and sellers that each has

only a small impact on the marketiv) Imperfect market is a market in which either the buy or seller has an influence on the

market e.g. a monopoly b) What is Demand?

i) The quantity demanded is the amount of a good or service that buyers are willing and able to purchase at the current price

ii) The law of demand states, all other things being equal, the quantity demanded falls when the price rises, and the quantity demanded rises when the price falls

iii) The demand curve is a graph that illustrates the relationship between the prices in the demand schedule and quantity demanded at those prices market demand is the sum of all the individual quantities demanded by each buyer in the market at each price

iv) A price change causes a movement along a given demand curve, but it cannot cause a shift in the demand curve

v) Factors that shift the demand curve:(1) Change in income

(a) More income means more money to spend. Whether consumption of a good goes up depends on the type of the good:(i) A consumer will buy more of a normal good if the consumer’s income goes up(ii) Consumer buys less of an inferior good as income rises, holding other things

constant (because they can afford something better)(2) The price of related goods

(a) Certain good directly affect the demand for other goods:(i) Complements are two goods used together When the price of a

complementary good rises, the demand for the related good goes down(ii) Substitutes are two goods that are used in place of one another when the

price of a substitute good raises, the demand for it and the related good goes up.

(3) Changes in tastes and preferences(a) Subjective changes in fashion trends:

(i) Currently in style: Demand rises(ii) Falls out of style: Demand falls

(4) Expectations regarding the future prices(a) If we expect a price to be higher tomorrow, we are likely to buy more today to beat

the price increase(b) If we expect a price to decline soon, you will delay your purchase to capitalize on a

lower price in the future(5) The Number of buyers

(a) The market demand curve is the sum of all individual demand curves, so increases in the number of individuals, etc.

c) What is Supply?i) The quantity supplied is the amount of the good or service that producers are willing and

able to sell at the current price ii) The law of supply states that, all other things being equal, the quantity supplied increases

when the price rises, and the quantity supplied falls when the price falls iii) A supply curve is a graph of the relationship between the prices in the supply schedule and

the quantity supplied at those prices sellers are more willing to supply the market when prices are high, since this generates more profits for the business

iv) The market supply is the sum of the quantitates supplied by each seller in the market at each price

v) A price change causes a movement along a given supply curve, but it cannot cause a shift in the supply curve

vi) Factors that shift the supply curve:(1) Changes in cost of inputs

(a) Inputs are the resources used in the production process. If the cost of input declines, profit margins improve more firms willing to supply the good

(2) Changes in technology or the production process(3) Taxes and subsidies

(a) Taxes placed on suppliers are an added cost of doing business. Passing it onto to the customers would drive sales down and reduce profits.

(b) The reverse is true for a subsidy, which is a payment made by the government to encourage consumption or production of a good or service

(4) Expectations regarding the future prices(a) A seller who expects a higher price for the product in the future may wish to delay

sales to capture the higher prices(5) The number of firms in the industry

d) Supply, Demand and Equilibrium(1) Equilibrium occurs when the price causes the quantity supplied (Qs) to be equal to the

quantity demanded (Qd) Qd = Qs(2) the price at this point is called the equilibrium price or market clearing price(3) the same principle for the equilibrium quantity(4) law of supply and demand: the price of any good will adjust to bring Qd and Qs into

balanceii) Surpluses and Shortages

(1) Surpluses occur when Qd < Qs and shortages occur when Qd > Qs(2) In case of a shortage: Buyers who are unable to find enough compete to find the good,

drives the price upward(3) In case of a surplus: business must lower to reduce inventories, drives prices down (4) When one curve shifts, we can tell how both quantity and demand will be affected(5) When both curves shift, we can only tell either quantity or demand change

D) Chapter 6: Introduction to Macroeconomics and Gross Domestic Product a) What Does GPD Tell Us about the Economy?

i) The total output of an economy is used as a gauge of its overall health (1) An economy that produces a large amount of valuable output is a healthy economy(2) The total output gives a good indication of the overall health of the economy

ii) Production Equals Income: (1) Gross Domestic Product (GDP) is the market value of all final goods and services

produced within a nation during a specific period of time (2) GDP mainly measures the output of the economy but also the income

iii) 3 Uses of GDP:(1) Measuring Living Standards: Using GDP isn’t perfect but can be used to look to relative

living standards use GDP per Capita for the comparison

(2) Measuring Economic Growth: When economics grow, living standards rise, and this outcome is evident in the GDP data. We have to adjust data for inflation (the growth in the overall price levels in the economy). Real GDP is the adjusted GDP, on the basis of inflation. Economic Growth is the measured as the percentage change in real per capita GDP.

(3) Measuring Business Cycle: GPD can be used to determine whether the economy is expanding or contracting. (a) Recessions are short – term economic downturns that typically last 6 – 18 months(b) If an economy is expanding or contracting, there are indicators using GDP.(c) Business Cycles are short – term fluctuations in economic activity

b) How is GDP computed?i) Counting market value: we have to use the market values of the goods and services sold to

compute the GDP of an economy ii) Including Goods and Servicesiii) Including Only Final Goods and Services: Final goods are goods that are sold to final users of

the product. Intermediate Goods are not included in the calculations avoids double counting

iv) Within a Country: Gross National Product is an alternative to the GDP, which only includes all the things produced by nationals of a country who are living overseas

v) Including only production from a particular periodc) Looking at GDP as Different Types of Expenditures

i) BEA breaks GDP down into four major categories: consumption (C), investment (I), government purchases (G), and net exports (Nx)

ii) Consumption: is the purchase of final goods and services by households with the expectation of new housing (1) Two categories of consumption goods: non – durable and durable consumption goods

iii) Investment: is the private spending on tools, plants and equipment used to produce future output. Business inventories are included in the investment portion of the GDP formula

iv) Government Spending: spending by all levels of government on final goods and services. Transfer payments do not count toward the GDP calculation because they just move income from one group to another.

v) Net Exports: exports minus imports of final goods and services d) Real GDP: Adjusting GDP for Price Changes:

i) GDP calculated using current prices is called nominal GDP this can be adjusted to real GDP by using historical prices. The difference between nominal GDP and real GDP is equal to inflation.

ii) To compute the real GDP you need to have the overall prices, known as the price level. The price level is an index of the average prices of goods and services throughout the economy. The price level we use to adjust GDP is called the GDP deflator includes the prices of the final goods and services counted in the GDP. (1) Real GDP = [(nominal GDP) / (price level)]*100

e) Growth Rates:

i) Nominal GDP Growth = % change in Nominal GDP ii) Price Level Growth Rate = % change in Price Leveliii) Growth of Nominal GDP = growth of Real GDP + growth of Price Level

f) What are some shortcomings of GDP?i) Non – Market Goods: many goods and services are produced but not sold so they are not

accounted for in the GDP. The less developed the market, the more unreliable the GDP is. ii) Underground Economy: this encompasses transactions that are not reported to the

government. iii) Quality of the Environment: the GDP can only determine the market value of the

goods/services produced but not the way in which they are produced. So two countries might have the same GDP but the quality of life is much lower in one because pollution, etc.

iv) Leisure Time: is not accounted for. Workers in one country may produce the same amount but at a much lower number of hours.

E) Chapter 7: Unemployment a) What are the Major Reasons for Unemployment?

i) Unemployment occurs when a worker who is not currently employed is searching for a job without success. The amount of people unemployed is measured via unemployment rate

ii) Three types of unemployment:(1) Structural Unemployment: dynamic and growing economies, adapt to change. Some

positions will become obsolete, which is explained by creative destruction. Whenever new technology or products are introduced, some industries will lose some jobs. This process leads to structural unemployment.

(2) Frictional Unemployment: caused by delays in matching available jobs and workers. This is also a type of natural unemployment. Due to imperfect information. Frictional unemployment is determined by information availability and government policies. Factors that increase the job – search process increase frictional unemployment. Government regulations can increase or decrease the frictional unemployment by making it harder to fire and hire people.

(3) Cyclical unemployment: caused by recession or economic downturns. Means that people want to work, but there aren’t any jobs for them. Structural and frictional are inherent parts of a healthy economy, cyclical unemployment is not.

iii) The Natural Rate of Unemployment: the natural rate of unemployment (u*) is the typical rate of unemployment that occurs when the economy is growing normally. When the unemployment rate is equal to the natural rate, the economy is operating at full employment output (Y*). Y* is the potential output, unless additional changes are made, the economy cannot sustain output above this amount.

b) What can we learn from the Employment Data?i) The Unemployment Rate = u = (number unemployed)/(labor force)

(1) Labor force is the defined as someone who is already employed or actively seeking work. If they have not sought a job in four weeks, they are no longer in the labor force. People not included in the labor force: retirees, stay at home parents, people who are in jail, military personnel, children under age of 16, and many full – time students

ii) The Shortcoming of Unemployment:(1) Discouraged workers are not included in the calculation. These are the people who are

not working, have looked for a job in the last 12 months and are willing to work, but have not sough employment in last 4 weeks.

(2) Unemployed workers are those who have part time jobs but would like full time jobs. Including discouraged and unemployed would drastically increase the unemployment rate.

(3) BLS keeps track of the average length of time that a person is unemployed for further insights

iii) Other Labor Market Indicators(1) Labor Force Participation: is the portion of the population that is in the labor force. (2) Gender and Race Statistics

F) Chapter 8: The Price Level and Inflation a) How is Inflation Measured?

i) The Consumer Price Index (CPI) (1) The consumer price index (CPI) is the measure of the price level based on the

consumption patterns of a typical consumer. Basically a basket of goods that a typical consumer in America would buy. ON AVERAGE. (a) Computing CPI: BLS conducts survey by sending employees into stores in 38

geographic regions to gather and input price information on over 8,000 goods. (b) Price Index = (basket price/basket price in base year) * 100(c) Steps:

(i) Define the basket of goods and services and their appropriate weights(ii) Determine the prices of goods across periods(iii) Convert to the index number each period

ii) Measuring Inflation Rates(1) The inflation rate (i) is calculated as the percentage change in the price level (P).

(a) Inflation rate = (P2 – P1)/P1 * 100iii) Using CPI to Equal Dollar Values Over Time:

(1) Price in today’s dollars = Price in Earlier Time * (Price Level Today/Price Level in Earlier Time)

(2) CPI is not that accurate because consumers change their basket of goods over time. (a) Three reasons for the concerns regarding CPI:

(i) Substitution: when prices rise, we look for substitutes. The CPI does not acknowledge the substituting nature of the consumer.

(ii) Changes in Quality: the classic Titanic vs. Avatar. The increase in quality means increase in prices. BLS does have adjustments for this.

(iii) New Products and Locations: BLS does not update the basket that often. BLS began computing the chained CPI which is a measure of the CPI in which the typical basket is updated monthly. Better indicator of the inflation.

b) What Problems Does Inflation Bring?i) Inflation reduces the purchasing power of their income, if they are tied down to contracts.

ii) Shoe leather costs: the resources that are wasted when people have to change their behavior to avoid holding money. The value of the dollars in your pockets falls when inflation rises.

iii) Money Illusion: people interpret nominal changes as real changes. iv) Menu Costs: the cost of changing prices to keep up with inflation. v) Uncertainty about Future Price Levels:

(1) Funds must be spent today to get returns tomorrow. Businesses make promises of payment to suppliers, workers, and etc. When people don’t know what is going to happen in terms of inflation, they are less likely to take promise of payment in the future.

(2) Output is the production that a firm creates. vi) Wealth Redistribution: inflation can also redistribute wealth between borrowers and

lenders. If inflation occurs, the value you repay is less than the value you got from the lender. Banks compensate for this by asking for higher interest rates.

vii) Price confusion: firms use prices as signals within the markets. Firms take rising prices as a signal to increase output and falling prices as a signal to decrease supply. If the inflation occurs and confuses the supplier, they may misallocate the resources.

viii) Tax Distortions:(1) Capital Gains Tax: taxes realized by selling an asset for more than its purchase price. The

nominal value may have gone up but the real value may have stayed the same or even declined.

c) What is the Cause of Inflation? i) Increasing the supply of money more than the quantity of good and services provided tends

to be the main reason why inflation occurs. G) Chapter 9: Savings, Interest Rates, and the Market for Loanable Funds

a) What is the Loanable Funds Market?i) Loanable funds market is the market where savers supply funds for loans to borrowers

(1) Stock markets, investment banks, mutual fund firms and commercial banksii) Savings flow from savers to borrowers in the loanable funds market.

(1) Savers are the suppliers of the funds and borrowers are the demanders(2) Households are the primary suppliers of the funds

iii) Firms borrow to invest firms looking to get the future output, must invest todayiv) An interest rate is the price of the loanable fundsv) Expressing Interest Rates as a Reward for Savings

(1) Interest rates are the return you get for supplying funds. Interest serves as the opportunity cost of consumption

vi) Interest rates are the costs of borrowing (1) Profit maximizing firms borrow to fund an investment if and only if the expected return

on the investment is greater than the interest rate on the loan vii) How inflation affects interest rates:

(1) Real interest rate is the interest rate that is corrected for the inflation represents real returns

(2) Nominal interest rates is the interest rate before it is corrected for inflation; it is the stated interest rate

(3) Fischer Equation: gives the relationship between inflation and interest rates(a) Real Interest Rate = Nominal Interest Rate – Inflation Rate

b) What Factors Shift the Supply of Loanable Funds?i) Income and Wealth:

(1) The increase in wealth would not be spent immediately, rather the people would save itii) Time Preferences

(1) Time preference refers to the fact that people prefer to receive goods and services sooner rather than later. Least patient people will have strong time preference and will save less. People with lower time preferences save more.

iii) Consumption Smoothing(1) Income varies drastically over your life time, and when that happens, your saving and

consumption depend on the age. (2) Early in life you spend more than we earn, so we borrow. In the middle of the life, you

spend less than you earn, so you save. And then late in life after retirement you save less than you earn so you dissave.

c) What factors shift the demand for the loanable funds?i) Productivity of Capital

(1) When productivity of capital increases, the return on investment goes up so firms are encourage borrowing to invest in capital.

ii) Investor Confidence(1) Investor Confidence is a measure of what firms expect for future economic activity(2) Increased investor confidence, increases the demand for the loans

H) Chapter 10: Financial Markets and Securities a) How do financial markets help the economy?

i) In markets, borrowers and lenders come together. The buys in financial markets are firms and governments in search of funds to undertake their daily operations.

ii) Majors players in the financial markets are called financial intermediares that help channel funds from the savers to borrowers. Banks are private firms that accept deposits and extend loans.

iii) Direct and Indirect Financing(1) Indirect Finance is through the banks, you deposit and someone else borrows. (2) Direct Finance is when the money goes directly to the borrower e.g. bonds and stocks

(a) Securities are tradable contracts that entitles the owner to certain rightsiv) Importance of Financial Markets

(1) Funds to invest come from financial marketsb) What are the Key Financial Tools for the Macroeconomy?

i) Bonds (1) Basically an IOU contract (2) Three important pieces of information:

(a) Maturity date is when the repayment is due

(b) Face Value the amount due at maturity(c) Interest Rate of Bond = R (Face Value – Initial Price) / (Initial Price)

(i) Dollar price and interest rate have an inverse relationship(3) Default Risk is the risk that the person does pay the fave value at the maturity date

(a) Greater the risk, the lower the price of the bond (b) Bond interest rates rise with the default risk

ii) Stocks (1) Ownership stakes in the firm. You get a stake in the firm.

iii) Secondary Markets (1) Markets that are used to trade after the initial issuance of the debt/stock(2) NYSE, NASDAQ(3) Existence of a secondary market for the security increases the demand for the security

(a) Felxibility is given in the selling of the bond/stock iv) Treasury Securities

(1) Are the bonds sold by the US Federal Government and are sold at auction price. So the price at the auction determines the price of the security.

(2) Less risky than just about every other security, used as a way to limit risk. v) Home Mortgages

(1) Have grown in importance over the last 30 yearsvi) Securitization

(1) Involves creating a new security by combing otherwise separate loan agreements (2) Decreases the interest rate, but needs to be further examined when you buy the newly

formed securitiesI) Chapter 11: Economic Growth and the Wealth of Nations

a) Why Does Econonmic Growth Matter?i) Measuring Economic Growth

(1) Economic Growth = %Change in Nom. GDP - %Change in Price Level - %Change in Pop.(2) Economic Growth is the growth rate of real per capita GDP(3) Represent the change in the average person’s income adjusting for price and pop.

ii) Rule of 70: if growth rate is x percent, then the variable doubles every 70/x yearsb) What are the causes of economic growth?

i) The sources for growth are:(1) Resources

(a) Land(i) Physical land, natural resources

(b) Labor(i) Represents workers in an economy.

1. Effective Labor metric adjusts for training and education(c) Capital

(i) Tools and equipment used in the production of goods and services(ii) Factories, computers and roads

(2) Technology

(3) Institutions(a) Political Stability and Rule of Law(b) Private Property Rights(c) Stable Money and Prices

(i) Without stability people are reluctant to invest because their investment might lose value because of inflation and such

(d) Competitive Markets(e) Efficient Taxes

J) Chapter 12: Growth Theory a) How Do Macroeconomic Theories Evolve?

i) The Evolution of Growth Theory(1) Began with Solow Model

b) What is the Solow Growth Model?i) We focus mainly on physical capital ii) A nation’s production function:

(1) Describes the relationship between inputs and the outputs of that economy(a) We extend the production function to the aggregate production function which

describes the relationship among all the inputs used in the macro economy (b) GDP = Y = F(Physical Capital, Human Capital, Natural Resources)(c) The first version of the Solow Model focused on capital

(i) Increasing the tools available can increase output per worker(ii) Capital stock in wealthy nations exceeds capital in developing nations(iii) Periods of investment growth are periods of expansion

iii) Two Theoretical Implications(1) Steady States

(a) Defined as the long run equilibrium point in which there is no new investment. Just reinvestment of broken down parts

(b) Steady states is a direct implication of diminishing returns: when the marginal return to capital declines, at some point there is no incentive to build more capital

(c) At SS: net investment = 0(2) Convergence

(a) Per capita GDP levels across nations will equalize. Just because everyone will reach steady state, doesn’t mean everyone did

(b) Doesn’t necessarily occur, the model was missing somethingiv) Solow II:

(1) Y = A x F(Physical Capital, Human Capital, Natural Resources)(2) The second model accounts for the technology because it allows us to produce more

output with each input(3) The first assumption was that the technology change is exogenous it just happens,

random changes to the economyv) Solow III:

(1) Adapted after policy failures in foreign aid

(2) Determined that the technology is not exogenous, it is endogenous which is spurred by the existence of the institutions

(3) So new equation(a) Y = A x F(Physical Capital, Human Capital, Natural Resources, Institutions)

(i) Negative institutions = corruption, political instabilityK) Chapter 13: The Aggregate Demand – Aggregate Supply Model

a) What is the Aggregate Demand – Aggregate Supply Model?i) Macroeconomics focuses on the business cycle ii) Aggregate demand is the total demand for final goods and services in an economy

(1) AD = C + I + G + Nx(2) The Slope of the Aggregate Demand Curve

(a) Increases in the economy’s price levels lead to decrease the amount of goods demanded.

(b) The reason for the downward sloping demand curve is not just substitution effect like it is with the normal supply curve. The reasons are:(i) Wealth Effect: is the value of an individual’s accumulated assets. When price

level increases, real wealth decrease. Increasing price levels will decrease your purchasing power, which reduces spending and decreasing the quantity of goods.

(ii) The Interest Rate Effect: If the price level increase and real wealth falls, people save less, which increases the interest rate. Reduces the quantity invested.

(iii) The International Trade Effect: occurs when a change in the price level leads to the change in the quantity of net exports demanded.

(c) Shifts in the Aggregate Demand(i) Real Wealth: House values (ii) Expected Income(iii) Expected Prices(iv) Foreign Income(v) Value of the Dollar

iii) Aggregate supply is the total supply of final goods in an economy(1) LRAS: the long run output of an economy depends on the resources, technology and

institutions(2) The SRAS: is positively sloped and depends on the price level

(a) Why is it upward sloping in the short rung:(i) Sticky Input Prices

1. Tend to be sticky, set by contracts. Output prices are flexible, easier to change. If output prices rise, the output is increased to maximize profits.

(ii) Menu Costs(iii) Money Illusion

(b) Shifts in SRAS:(i) Temporary Supply Shocks: an event that affects aggregate supply

(ii) Changes in expected future prices: if workers and firms expect higher prices tomorrow, they negotiate those expectations into today’s contracts. Costs are higher, and the short run AS shifts left.

(iii) Adjustments to errors in past price expectationL) Chapter 14: The Great Recession, The Great Depression and Great Macroeconomic Debates

a) The Recession of 2008:i) Trouble in the financial markets in 2007:

(1) Declining real estate values in 2007. Many mortgages were securitized(2) Falling real estate values therefore led to a systematic problem in the US financial

markets(3) These markets exhibit international interdependence, and the problem became a

worldwide problem (4) Breakdown in the loanable funds market(5) Institutional Breakdown

M) Chapter 15: Federal Budgets: The Tools of Fiscal Policy a) How Does the Government Spend?

i) Government Outlays:(1) Transfer payments are payments made to groups or individuals when no goods or

services are received in return. (2) Government outlays are the parts of the government budget that includes both

spending and transfer payments. The largest portion of the government outlays is mandatory outlays, determined by law such as social security.

(3) Discretionary outlays comprise government spending that can be altered when the government is setting its annual budget. Only 36.3 percent is discretionary spending. Mandatory is 57.4 percent.

(4) Spending and Current Fiscal Issues(a) Increased spending on Social Security and Medicare(b) Defense spending in the wake of the terrorist attacks(c) Government responses to the Great Recession, beginning with fiscal policy in 2008

b) How Does the Government Tax?i) Sources Tax

(1) Payroll Taxes(2) Corporate Taxes(3) Social insurance taxes

ii) Debt = sum of all yearly deficitsN) Chapter 16: Fiscal Policy

a) How Does Fiscal Policy Work?i) The use of government spending and taxes to influence the economyii) Taxes and spending changes must be legislated iii) Expansionary Fiscal Policy

(1) Government increases spending or decreases taxes to stimulate or expand economy(2) Two previous examples

(3) Increase government spending [G](4) Decrease Taxes [T]

iv) Contractionary Fiscal Policy(1) Pay off government debt(2) Keep economy from expanding long run capabilities

v) Fiscal policy is countercyclical (1) Used to smooth out cycles(2) Expansionary during recessions and contractionary during expansions

b) Multipliersi) MPC

(1) MPC = (Change in Consumption)/(Change in Income)(2) Spending Multiplier: MS = 1 / (1 – MPC)

c) Why Doesn’t Fiscal Policy Work Perfectly?i) Time Lags

(1) Recognition Lag(2) Implementation lag(3) Impact Lag Contractionary policy might high when the economy is contractin

ii) Crowding Outiii) Savings Adjustments People know that they have to pay for the fiscal policy later so they

adjust savingsd) Supply – Side Fiscal Policy

i) Use of government spending and taxes to affect the supplyii) Focus on savings iii) R&D Tax Credits – gives firms an incentive to spend resources on technological

advancementiv) Policies that focus on education – subsidies or tax breaks for education (like Pell Grants)

create incentives to invest in education, increasing labor resourcesv) Lower Corporate Profit Tax Rates – incentives for corporations to understake acitivies that

add more profitvi) Lower Marginal Income Tax Rates – create incentives for individuals to work harder produce

more, since they get to keep a larger share of their incomevii) Laffer Curve Shows the Relationship Between Tax Revenue and Tax Rate

O) Chapter 17: Money and the Federal Reserve a) How Money is Defined and Measured?

i) Importance of the quantity of money(1) Affects the ease of making purchases(2) Affects price level

ii) Currency(1) Paper bills and coins used to buy services(2) However, we make many purchases without currency

iii) Functions of money

(1) Medium of Exchange: Money is how we pay for goods and services. This is called a double coincidence of wants doesn’t occur very often. (a) Commodity money, commodity backed money, fiat money

(2) A unit of account: the measure in which prices are quoted. Creates a common language by placing a value on a good that everyone can understand.

(3) Store of value: a means for holding wealth.iv) M1 = currency + checkable deposits checkable deposits = bank deposits that allow

depositors to withdraw money by writing checksv) M2 = M1 + savings deposits + money market mutual funds + CDs

b) Bank Reservesi) Fractional Reserve Banking

(1) Banks only hold a fraction of deposits on revenue(2) Alternative would be 100 percent – reserve banking, where banks don’t loan out

deposits ii) Two reasons to hold reserves

(1) Banks need to accommodate customer withdrawals(2) Federal Reserve requires banks to hold a fraction of their deposits on reserve

(a) Fraction is called required reserve ratioiii) Bank Runiv) Required Reserves = rr x depositsv) Excess Reserves = total reserves – required reserves

c) How Banks Create Money?i) While they don’t print money, they loan out part of their deposits to create new moneyii) Simple money multiplier: rate at which banks multiply money when

(1) All currency is deposit into banks and(2) They hold onto excess revenues

(a) Mm = 1 / (rr)(3) Represents maximum size of money multiplier

d) Federal Reserve i) Federal Reserve Responsibilities:

(1) Monetary policy(2) Central Banking

(a) Banks for Banks – offers support and stability for banking(b) Federal Funds private bank deposits at the federal reserve, to lend between

banks(c) Federal Funds the interest rate on loans between private banks(d) Discount Loan loans from the Fed to private banks “lender of last resort”

(3) Bank Regulation(a) Sets and monitors reserve requirements, limits risks

ii) Current Chairman: Ben Bernanke and future Chairman: Janet Yellene) Monetary Policy Tools

i) Open Market Operations

(1) Primary single tool of monetary policy(2) Fed created a new version in 2008

ii) Secondary tools(1) Reserve requirements (2) Discount rates

iii) Quantitative Easing(1) Targeted use of open market operations where the central bank buys securities

specifically targeted in certain markets(2) Targeted the housing market(3) Unprecedented – it amounts to the fed printing trillions of new dollars and putting them

in targeted sectors (4) Variety of new tools: loans by consumers, students, small businesses, and short term

corporate bonds. Money doesn’t just mean currency - also includes bank depositsP) Chapter 18: Monetary Policy

a) What Is the Effect of Monetary Policy in the Short Run?i) Expansionary Monetary Policy

(1) Done through OMO: Buys Bonds(2) Increased supply of funds lowers the interest rates and firms take more loans(3) Short run, expansionary monetary policy increase real GDP and reduces unemployment(4) Overall price level rises as flexible prices increases

ii) Contractionary Monetary Policy(1) Occurs when a central bank takes action to reduce the money supply(2) Often done during times of rapid expansion in order to curb potential inflation(3) Sell Bonds. Raises the interest rate.

iii) Why Doesn’t Monetary Policy Always Work(1) Just like fiscal policy, monetary policy has its flaws that can decrease effectiveness.

(a) Diminished effects in the long run (b) Expectations reducing the effects of policy(c) Policy is limited if downturns are caused by AS shifts rather than AD shifts

(2) In the long run, output doesn’t change and unemployment doesn’t change. Price level increases

iv) Phillip’s Curve(1) In 1960’s economists noticed inverse relationship between unemployment and inflation(2) LR Phillip’s Curve – vertical, rather downward sloping

v) Expectations and the Phillip’s (1) Zero Inflation Expectations: implicit assumption that all inflation is a surprise(2) Adaptive Expectations: based on last year’s inflation(3) Rational Expectations

Q) Chapter 20: International Finance a) Why Do Exchange Rates Rise and Fall?

i) Exchange rate is the price of the currency ii) Characteristics of Foreign Exchange Markets

(1) Demand for foreign currency is a derived demand(2) Derived Demand is the demand for a good or service that derives from the demand for

another good or serviceiii) Appreciation and Depreciation

(1) Currency appreciation occurs when a currency becomes valuable relative to other currencies

(2) When exchange rates rise, foreign currencies become more expensive relative to dollar(a) Imports become more expensive(b) US exports become less expensive

iv) The Demand for Foreign Financial Assets(1) You have to convert to the local currency(2) A primary reason why foreigners demand US dollars is to buy US stocks, bonds, and real

estate (3) One key factor in foreign exchange is interest rates across nations

b) What is Purchasing Power Parity?i) The Law of One Price

(1) That after accounting for transportation costs and trade barriers, identical goods sold in different locations are the same price

c) What is Purchasing Power Parity?i) Pa = Exchange Rate * Pbii) Big Mac Index

(1) Why PPP does not hold perfectly?(a) Goods and services must be identical in different(b) Some goods and services are not tradeable(c) Trade barriers inhibit the trade of goods across some international borders(d) Shipping costs keep prices from completely equalizing (e) PPP is a theory about the long – run price adjustments across nations

d) What is Balance of Payments?i) BOP is divided into two major accounts:

(1) Current Account – tracks all payments for goods and services, current income and gifts(2) Capital Account – tracks payments for real and financial assets between nations an

extentions of international loans(3) Sometimes called financial account

ii) Current Account Balance + Capital Account = 0e) Causes of Trade Deficits

i) Strong Economic Growth(1) Two Complementary effects:

(a) Wealthy domestic consumers can afford more imports(b) Growing economics offer higher investment returns, so funds from the rest of the world flow in

ii) Declining Domestic Savings(1) Filled by foreign investments

iii) Government budget deficits