Unit VII (Absolute and Comparative Advantage)

• Absolute Advantage:

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

·         National-exists when a country can produce more o a good/ service than another county can in the same time period.

• Comparative Advantage:

-A person or a nation has a comparative advantage in the production of a product when it can produce the product at a lower domestic opportunity cost than can a trading partner.

                                       

• Specialization and Trade:

-Gains from trade are based on comparative advantage, not absolute advantage.

• Examples of Output Problem:

- per acre 

-miles per gallon

-word per minute

-apple per tree

-television produced per hour

• Examples of Input Problems:

-number of hours to do a job

-number of acres to feed a horse

-number of gallon of paint to paint a house

Unit VII (Foreign Exchange)

• Foreign Exchange:

-  Buying and selling of currency-Any transactions that occurs in the balance of payments necessitates foreign exchange-Exchange Rate (ex): is determined in the foreign currency markets

• Changes in Exchange Rates:

-Exchange rates (e) are a function of supply and demand for currency- an increase in the supply of a currency- a decrease in supply of a currency will increase the exchange rate of currency- increase in demand for currency will increase the exchange rate of currency- decrease in demand for a currency will decrease the exchange rate of currency
Appreciation and Depreciation:·         Appreciation of currency occurs when exchange rate of that currency increases (e^)
·         Depreciation of a currency occurs when the exchange rate of that currency decreases

• Exchange Rate Determinants:

-Consumer tastes-Relative income-Relative price level-Speculation
-Exports and Imports:·         Exchange rate is a determinant of both exports and imports
·         Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper, thus reducing exports and increasing imports
·         Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports

• Floating/ Flexible Rates:

Depends upon supply and demand of that currency vs. other currenciesVery sensitive to business cycle / provide options for investments
Fixed Rates:Based on a country's willingness to distribute currency and to control the amount
As two currencies trade:1.    One supply line will ∆, the other demand line will ∆.
2.    They will move in the same direction
3.    One currency will appreciate, the other will depreciate

Unit V( Balance of Payments)

• Definition: Measure of many inflows and outflows between the U.S and the rest of the world (ROW)

Inflows are referred to as CREDITS
Outflows are referred to as DEBITS 
Balanced of payments is 8 into 3 accounts
-current
-capital/financial
-official reserves

• Current Account

Balance of trade or net exports
-Exports of goods/services.
-Exports create a credit to balance of payments.
-Imports create a debit to the balance of payments. 
-Net foreign income
-Income earned by U.S foreign held U.S assets.
-Ex: interest payments on U.S owned Brazilian bonds-interest payments on German owned U.S Treasury bonds
-Net transfers (Tend to be unilateral)
-Foreign aid-debit to the current account
Ex: Mexican migrant workers send money to their families in Mexico.

• Capital/Financial Account

-Balance of capital ownership 
-includes purchase of both real and financial assets.
-Direct investment in the U.S is a credit to the capital account.
-Ex: Toyota Factory in San Antonio
-Direct investment by the U.S firms/ individuals in a foreign country are debits to the capital account. 
-Ex: Wareen Buffet by stock in Perochina 
Purchase of domestic financial assets by foreigners represents a credit to the capital account.
-United Arab Emirates \wealth funds purchases a large state in the NASPAQ 

• Relationship between current and capital account

-Remember double entry bookkeeping.

Current account and capital account should zero each other out. 

-That is if current account has a negative balance (deficit), then the capital account should then have a positive balance (Surplus)

• Official Reserves

 Foreign currency holdings of the U.S Federal Reserve System 

When there is a balance of payments surplus the Fed accumulates foreign currency and debits the balance of payments. 

When there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments. 

Official reserves zero the balance of payments. 

• Active V. Passive Official Reserves

-U.S is passive in its use of official reserves. It does not seek to manipulate the money exchange rate.

• Balance of Trade

Goods + goods

Exports  Inputs

• Balance on goods and serves

Goods + Services + Goods + service

Exports  Exports     Inputs     Inputs

• Current Account

Balance on goods and services + Net investments + net transfer

• Capital Account

Foreign Purchase + domestic purchase.

 

Unit V (Extending the Analysis of AS)

• Short Run Aggregate Supply:

-Period in which wages and other input prices remains fixed as price level increase or decrease.

• Long Run Aggregate Supply:

-Period of time in which wages have become fully responsive to change in price level.

• Effects over short-run:

-In short run, price level changes allow for companies to exceed normal outputs and hire more workers because profits are increase while wages remain constant.

In the long run, wages will adjust to the price level and previous output levels will adjust accordingly.

• Equilibrium in the Extended Model:

=The extended model means the inclusion of both the short run and long run AS curves.

The long run AS curve is representative with a vertical line.

Demand pull inflation in the AS model.

Demand pull : prices increase based on the increase in AB

In Short run, demand pull will drive up prices and increase production.

In long run, increase in AB will eventually return to previous level. 

• Cost Push and the Extended Model:

cost-push arises from factors that will increase per unit cost such as increase in the price of a key resource. 

Short run shifts left. What is important is that in this case, it is the cause of price level increase, not the effect. 

• Dilemma for the Government:

In an effort to fight cost-push. The government can react in two different ways.

Action such as spending by the government could begin an inflationary spiral.

No action however could lead to recession by keeping production and employment levels declining. 

• The Long-Run Phillips Curve:

Natural rate of unemployment is held constant.

Because the Long Run Phillips curve exists at the natural rate of unemployment (UN) Structural changes in the economy that UN will also cause the Long-Run Phillips Curve to shift.

Increase in UN will shift Long-Run Phillips Curve right.

Decrease in UN will shift Long-Run Phillips Curve left.

• Short Run Phillips Curve:

Trade of between inflation and unemployment.

• Long Run Phillips Curve:

NO trade of between inflation and unemployment in the long run.

Occurs at natural rate of unemployment.

Represented by vertical line.

Long Run Phillips Curve will shift if the LRAS shifts.

Natural rate of unemployment is equal to frictional +structural + seasonal unemployment.

Maj LRPC assumption is that more worker benefits creates higher natural rates and fewer worker benefits creates lower natural rates. 

Supply Shock: Rapid and significant increase in resource cost, which causes SRAS curve to shift.

-Most likely shift to left and SRPC will shift right. 

Misery Intex: combo of inflation and unemployment in any given year.

Single digit misery is good. 

• Reaganomics/supply side economics 

Show change in AS not in AD, which determines the level of inflation, unemployment notes and economy growth.

Supply side economists, policies that promote GDP growth by arguing that high marginal tax votes along with the current system of transfer payments : Unemployment compensation welfare programs provide disincentive to work, invest, innovate and undertake entrepreneurial ventures. 

Low marginal tax rates induce more work, thus AS increase. 

-also makes leisure more expensive and work more attractive. 

• Incentives to save and invest: 

1) High marginal tax rates reduce the rewards for saving and investment.

2) Consumption might increase, but investments depend upon saving.

3) Lower marginal tax rates encourage savings and investing. 

• Laffer Curve:

Theoretical relationship between tax rates and government revenue. 

-As tax rates increase from (0) tax revenues increase from 0 to some max level and then declines. 

• Criticism of Laffer Curve:

Research suggests that the impact of the tax rates on incentives tow work, save, and invest are small.

Tax cuts increase demand, which can fuel inflation and demand may exceed supply.

Where the economy is actually located on the curve is difficult to determine. 

UnitI V (withdrawals and banking system)

• When a customer deposits cash or withdraws cash from their demand deposit, it has NO EFFECT on MONEY SUPPLY 

* It only changes
1. The composition of money
2. Excess reserves
3. Required reserves 

• Single bank (Chase) 

- can only loan money from excess reserves 

• Banking system (Chase, Wells Fargo, BOA, Fidelity)  

- ER x Multiplier (also equals total money supply) 
FED- When the FED buys or sells bonds, ED is created 
200 x Multiplier 

Monetary Policy

Unit 4 (Money & Banking / Monetary Policy Summaries)

Part 1: There are three types of money: commodity, representative, and fiat. Commodity money is a good that has other purposes other than money (i.e a farm animal). Representative money is money backed by something tangible (i.e gold coins). Fiat Money is money that has value because the Government says so. The three functions of money are: medium of exchange, store of value, and unit of account. Medium of exchange simply means we get what we pay for with money as a currency. Money is used because it has a store value, its worth stay stable fits is saved. Money is a unit of account, we use it to determine worth. 

Part 3: In money market graphs Demand slopes downward as it did in the supply and demand graphs because price and demand have an inverse relationship. The x-axis is labeled interest rates and the y-axis is labeled quantity. The supply of money is vertical because it does not vary based on the interest rate and it is fixed by the Fed. Certain factors that can shift the Demand is if there was an incentive to want more money via loans and etc. If people borrowing and spending more money, then the Demand will shift right. In effect it would put upward pressure on the interest rate. If the Fed wants to lower the interest rates in certain times such as an recession, they would in crease the money supply. 

Part 4: The Fed's tools of monetary policy are discount rates,  required reserves, and buy/sell government bonds and securities. In certain cases the Fed will increase or decrease the tools. If the Fed wants to expand the money supply they would decrease RR, buy bonds, and decrease discount rates. While, in an effort to contract the money supply the FED would increase the RR, increase, discount rates, and sell bonds. Reducing "interest rates" basically means buying or selling bonds to put downward or upward pressure on the Federal Fund Rate.

Part 7: On the loanable funds graph has the same axes as the Money Market graphs. Demand for loadable funds is downward sloping because when interest rates are lower, people demand more money and vice versa. Supply is upward sloping and it also dependent on savings.Savings is a positive factor in this market because the more people save, the more banks will have available. In order to shift the Supply curve left or right there must be an incentive or an lack of a incentive for people to save.  The money market and loanable funds are connected, loanable funds is the source of money for the money market. 

Part 8: Banks create money by making loans. Required Reserves are used as a tool to create money via loans, the RR takes a certain percentage out of deposits. Another way money is created is multiple deposit expansion. With one initial deposit from one person, the bank can loan a certain amount to another customer which they can put in their account, there is ann accumulation of money being circulated and created. 

Part 9: The money market, loanable funds market, and AD/AS market have affects on each other, The money market is where the government gets the money, the demand for loans increase for another source of money(government spending), and the AD increases because government spending is a determinant for the AS/AD market. The equation of exchange is MV=PQ can be used to explain the relationship, as price levels increase the interest rates increase. This can be explained by the "fisher effect." It ultimately means that there is a 1:1 ratio.

Unit IV( Basic accounting review)

• T-account (balance sheet): 

-statements of assets and liabilities 

• Assets(amounts owned): 

-items to which a bank holds legal claim 

-uses of funds by financial intermediaries

• Liabilities(amounts owed): 

-legal claims against a bank

-sources of funds for financial intermediaries  

• Federal Reserve Bank :

-uses paper currency

-holds reserves of the banks

-lends money and charges interests

-check clearing service for the bank

-personal bank for the government  

-supervises members  of banks  

-control money supply in economy  

• Reserve Requirement: 

-federal requires bank to always have some money readily available to meet consumer's demand for cash 

-amount set by the federal is required reserve

-the required reserve ratio is the % of demand deposits (checking account balance) that must not be loaned out 

-typically its 10% 

• Three types of multiple deposit expansion question:

1. Calculate the initial change in excess reserves:  aka the amount a single bank can loan from the initial deposit 
2. Calculate the change in the money supply
3. Calculate the change in the money supply: sometime type 2 and type 3 will have the same result  (if no Fed involvement)

1) The Reserve Requirement:

-only a small % of your bank deposit is in the safe the rest of your money has been loaned out

-this is called "Fractional Reserve Banking"

- the FED sets the amount that banks must hold

-the reserve requirement (reserve ratio) is the % of deposits that banks must hold in reserve and not loan out

-when the FED increases the money supply it increases the amount of money held in bank deposits  

-if there is a recession, what should the FED do to the reserve requirement?  

•  decrease the RR 

1. Banks hold less money and have more ER
2. Banks create more money by loaning out excess 
3. Money increase, interest rates fall, AD goes up  

 -if there is inflation what should the FED do to the reserve requirement, what should the FED do to the reserve requirement?  

•  decrease the RR 

1.  Banks hold more  money and have less ER 
2. Banks create less money 
3. Money Supply decrease, interest rates rise, AD goes down   

 2) The Discount Rate:

-Discount Rate is  the interest rate that the FED charges commercial banks 

 -Ex: If the banks of America needs $10 million, they borrow it from the U.S Treasury (which the FED controls, but they must pay it back with interest)

 -To increase the Money Supply, FED should DECREASE the Discount Rate (Easy Money Policy)

-To Decrease the Money Supply, the FED should INCREASE the Discount Rate (Tight Money Policy) 

 3) Open Market Operations:

-FED buys/sell government bonds (securities)

-This is the most important and widely used monetary policy

-To increase the MS, the FED should BUY government securities

-To decrease the MS, the FED should SELL government securities  

• Monetary policy:

-Expansionary: buy bonds, decrease discount rate, decrease RR = increase in loan, AD increases, GDP increase, MS increases. interest rate decreases 

-Contractionary: sell bonds, increase discount rate, increase RR= loans decrease, AD decrease. GDP decrease, MS decrease, interest rate increases   

*Federal Fund Rate: where FDIC member bank loans each other overnight funds
* Prime Rate: interest rate that banks give to their most credit- worthy customers  

Unit IV (Money)

• Uses of Money: 

-Medium of exchange: trade or barter

-Unit of account: establishes economic worth in the exchange process 

-Store of value: money has its value over a period of time, where products may not  

• Types of Money: 

-Commodity money: gets it value from the type of material from which it is made

    ex: gold and silver coins 

-Representative money: paper money backed up by something tangible that it gives it value  

Fiat Money: money because government says it is money and that is used in the U,S 

• Characteristics of money: 

-portable 

-durable

-uniform

-scarce

-acceptable 

-divisible  

• Money Supply:

-M1 money: currency (cash, coins, checkable deposits/ checking account, traveler's checks, and demand deposits) 

-75% of money in circulation and it mostly liquid because it easy ti convert to cash  

-M2 money: consists of M1 money  + savings accounts and deposits held by banks held outside of the U.S

-M3 money: consists of M2 money + certificates of deposits, known as CD's 

 

• time value of money:

Is a dollar today worth more than a dollar tomorrow?

-YES 

-Why?

-opportunity cost and inflation

-let v= future value of money

-let p= present value of  money

-let r= real interest rate (nominal rate- inflation rate) expressed as a decimal  

-let n = years

-let k= # of times interest is credited per year

-simple interest forumla: v=  (1+r)^n * p 

-compound interest forumla: v= (1+r/k)^nk *p 

• demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded  
• what happened to the quantity demanded of money when interest rates increase?

-quantity demanded falls because individuals would prefer to have interest rate assets instead of borrowed liabilities

• what happens to the quantity demanded when interest rates decrease? 

-quantity demanded increase, there is no incentive to convert cash into interest earning assets      

• Demand for money 

-money demand shifters:

1. change in price level
2. change in income 
3. change in taxation of investments

-How money supply affects AD? 

-money supply increases= decrease in interest rates, increase in investments, and decrease in AD

-money supply decreases = increase in interest rate, decrease in investment, decrease in AD

-Financial Assets vs Financial Liabilities 

-FA: assets such as stocks and bonds provide expected future benefits 

            - it benefits the owner, based upon the issue of the asset meeting certain obligations

-FL: liabilities incurred by financial asset to stand behind the issued asset  

-Interest rate: price paid for a financial asset 

-Stocks vs Bonds: 

-Stocks: assets that convey ownership in a company

-Bonds: promise to pay a certain amount of money + interest in the future

-What banks do?

- it is a financial intermediary  

-uses liquid assets (i.e. bank deposits) to finance the investments of borrowers

-process known as Fractional Reserve Banking

  - a system in which depository institutions hold liquid assets > the amount of deposits  

     -can take form of:  

• currency in bank vaults 

• bank reserves: deposits helad at federal reserves  

Unit III (Automatic or Built-In Stabilizers)

• Anything that increases the government’s budget deficit during a recession and increases its budget  surplus during inflation WITHOUT REQUIRING EXPLICIT ACTION BY POLICY MAKERS
• Economic Importance:
  -Taxes reduce spending and aggregate demand 
  -Reductions in spending are desirable when the economy is moving toward inflation
  -Increases in spending are desirable when the economy is heading toward recession.

• Progressive Tax System:
  
  
  -Average tax rate (tax revenue/GDP) rises with GDP
• Proportional Tax System:
  
  
  -Average tax rate remains constant as GDP changes
• Regressive Tax System:
  
  
  -Average tax rate falls with GDP
• The more progressive the tax system, the greater the economy’s built-in stability.

Unit III (Discretionary vs. Automatic Fiscal Policies)

• Discretionary:
  
  
  -Increasing or Decreasing Government Spending and/or Taxes in order to return the economy to full employment. Discretionary policy involves policy makers doing fiscal policy in response to an economic problem.
  
  
  -Example: Recession and Inflation
  
  
• Automatic:

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

-Example: Medicare and Medicaid

“Easy” Expansionary Fiscal Policy	“Tight” Contractionary Fiscal Policy
Combats Recession	Combats Inflation
Increases Government Spending Decreases Taxes	Decrease in Government Spending Increase in Taxes

• Automatic or Built-In Stabilizers:

-Anything that increases the government’s budget deficit during a recession and increases its budget  surplus during inflation WITHOUT REQUIRING EXPLICIT ACTION BY POLICY MAKERS

• Economic Importance: 

-Taxes reduce spending and aggregate demand  

-Reductions in spending are desirable when the economy is moving toward inflation 

-Increases in spending are desirable when the economy is heading toward recession

Unit III (Deficits, Surpluses, and Debt)

• Balanced Budget:
  -Revenues = Expenditures
• Budget Deficit:
  -Revenues < Expenditures
• Budget Surplus:
  -Revenues > Expenditures
• Government Debt:
  -Sum of all deficits - Sum of all Surpluses
• Government must borrow money when it runs a budget deficit. They borrow from:
  -Individuals
  -Corporations
  -Financial Institutions
  -Foreign Entities or Foreign Governments

• Fiscal Policy (Two Options):

• Discretionary Fiscal Policy (action)

-Expansionary fiscal policy - think deficit

• Contractionary fiscal policy - think surplus

-Non - Discretionary Fiscal Policy (no action)

Unit III (Fiscal Policy)

- Changes in the expenditures or tax revenues of the federal government.

• 2 tools of Fiscal Policy:
  -Taxes - government can increase order or decrease taxes
  -Spending - Government can increase or decrease spending

-Inverse relationship

Unit III (The Spending Multiplier Effect)

- An initial change in spending (C, IG, G, Xn) causes a larger change in any aggregate  Spending,or Aggregate Demand (AD).

-Multiplier = Change in AD / Change in Spending-Multiplier = Change in AD / Change in C, I, G, or Xn

• Calculating the Spending Multiplier:

-The Spending Multiplier can be calculated from the MPC or the MPS.

-Spending Multiplier = 1 / 1 - MPC or 1 / MPS-Spending Multipliers are (+) when there is an increase spending and (-) when there is a decrease in spending.

• Calculating the Tax Multiplier:

-When the government taxes, the multiplier works increase 

-Why?  

-Because now $ is leaving the circular flow.

-Tax Multiplier ( note: it’s negative)-Tax Multiplier = -MPC / 1 - MPC or -MPC / MPS-If there is a tax -CUT, then the multiplier is (+), because there is now more $ in the circular flow.

Unit III ( Marginal Propensity to Consume)

-The fraction of any change in disposable income that is consumed.

-MPC = Change in Consumption / Change in Disposable Income

-MPC = Change in Savings / Change in Disposable Income

• Marginal Propensities:

• MPC + MPS = 1
• .: MPC = 1 - MPC
• .: MPS = 1 - MPC
• Remember that people do two things with their disposable income, consume it or save it

Unit III (Disposable Income)

- Income after taxes or net income.

-Formula: DI = Gross Income - Taxes

-Two Choices

With disposable income, households can either :

• Consume (spend $ on goods and services)
• Save (not spend $ on goods and services)

• Consumption:

-Household Spending

-The ability to consume is constrained by:

-The amount of disposable income 

-The propensity to consume

-Do households consume if DI =0?
-No

• Saving:

-Household NOT spending 

-Ability to save is constrained by :

-Amount of DI

  - Propensity to consume

- Do households save if DI = 0?

-No

-APC and APS formulas:

• APC + APS = 1
• 1 - APC = APS
• 1 -  APS = APC
• APC > 1 (period of dissaving)
• -APS (period of dissaving)

Unit III (Shifts in Investment Demand)

• Cost of Production:

-Lower costs shifts ID right  

-Higher costs shifts ID left

•  Business Taxes:

-Lower business taxes shifts ID right 

-Higher business taxes shifts ID left

• Technological Change
  
  
  -New technology shifts ID right
  
  
  -Lack of technological change shifts ID left
  
  
• Stock of Capital:
  
  
  -If any economy is low on capital, then ID shifts right
  
  
  -If any economy has much capital, then ID shifts left
  
  
• Expectations:
  
  
  -Positive expectations shift ID right
  
  
  -Negative expectations shifts ID left
  
  
  

Unit III (Invest Rates and Investment Demand)

What is Investment?

- Money spent or expenditures on:

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

Expected Rates of Return

1. How does business make investment decisions?
1. Cost/ benefit analysis
2. How does business determine the benefits?
1. Expected rate of return
3. How does business count the cost?
1. Interest costs
4. How does business determine the amount of investment they undertake?
1. Compare expected rate of return to interest cost
• If expected return > interest cost, then invest
• If expected return < interest cost, then do not invest

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

What’s the difference?

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

1. How do you compute the real interest rate (r%)?
1. Formula: r% = i% - pi%
2. What then, determines the cost of an investment decision?
1. The real interest rate (r%)