Unit 6 notes

Economic Growth Defined

• Sustained increase in Real GDP over time
• Sustained increase in Real GDP per capita over time

Why Grow?

• Growth leads to greater prosperity for society
• Lessens the burden of scarcity
• Increases the general level of well-being

Conditions for Growth

• Rule of Law
• Sound Legal and Economic Institutions
• Economic Freedom
• Respect for Private Property
• Political & Economic Stability
• Low Inflationary Expectations
• Willingness to sacrifice current consumption in order to grow
• Saving
• Trade

Physical Capital

• Tools, machinery, factories, infrastructure
• Physical Capital is the product of Investment
• Investment is sensitive to interest rates and expected rates of return
• If takes capital to make capital
• Capital must be maintained

Technology & Productivity

• Research and development, innovation and invention yield increases in available technology
• More technology in the hands of workers increases productivity
• Productivity is output per worker
• More Productivity = Economic Growth

Human Capital

• People are a country’s most important resource. Therefore human capital must be developed
• Education
• Economic Freedom
• The right to acquire private property
• Incentives
• Clean Water
• Stable Food Supply
• Access to technology

Hindrances to Growth

• Economic and Political Instability
• high inflationary expectation
• Absence of the rule of law
• Diminished Private Property Rights
• Negative Incentives
• the welfare state
• Lack of Savings
• Excess current consumption
• Failure to maintain existing capital
• Crowding Out of Investment
• government deficits & debt increasing long term interest rates
• Increased income inequality -> Populist policies
• Restrictions on Free International Trade

Absolute vs. 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
• National
• exists when a country can produce more of a good/service than another country can in the same time period

Comparative Advantage

• Individual/National: exists when an individual or nation can produce a good/service at a lower opportunity cost than can another individual or nation
• Input Problems
• where the country who can produce a set amount of something by using the least amount of resources, land, or time has the absolute advantage
• chosen item / forgone item
• Output Problems
• who can produce the product the best
• what is given up / what is produced

Foreign Exchange Market

Buying and selling of currency

• In order to purchase souvenirs in France, first necessary for Americans to sell (supply) their dollars and buy (demand) Euros
• Exchange rate (e) is determined in the foreign currency markets and is the price of a currency
• Change the demand on one currency graph, change the supply on the other currency graph
• Move the lines on the two currency graphs in the same direction and you will have the correct answer
• If D increases on one graph, S increases on the other

Changes in Exchange Rates

• Exchange rates (e) are a function of the supply and demand for currency
• increase in supply of currency will make it cheaper to buy one unit of that currency
• decrease in supply of currency will make it more expensive to buy one unit of that currency
• increase in demand for a currency will make it more expensive to buy one unit of that currency
• decrease in demand for a currency will make it cheaper to buy one unit of that currency

1. Appreciation of a currency occurs when the exchange rate of that currency increases
2. Depreciation of a currency occurs when the exchange rate of that currency decreases

Purchasing Power Parity

• When the currency rates are set by international markets, changes will be based on the actual purchasing power of the currencies
• Ex.: If the US dollar to the European euro rate is 1.5 to 1, then each $1.50 will buy 1 euro. However, if an item in the US costs $1.50 and then costs more or less than 1 euro, the parity is lost. Markets will adjust quickly in floating rate or pressure for change will occur in fixed rates
• What is the need for exchanging currencies?
• Sell exports, buy immports
• Invest in other countries stocks and bonds
• build factory or store in other markets
• speculate on currency values
• hold currencies in bank acct. for future exports, imports and business loans
• to control excessive imbalances

Unit 7 notes

Balance of Payments
Measure of money inflows and outflows between the U.S. And rest of the works (ROW)
inflow = credit
outflows = debits
3 Acct balance is divided into
Current Acct
Capital Acct
Official Reserves
Double Entry Bookkeeping: every transaction in the balance of payments is recorded twice in accordance w/standard accounting practice.
Balance of Trade
Export of goods/service - imports of goods/services
Export create credit to balance of payments
Imports create debit to balance of payments
Net Foreign income
Income earned by US owned foreign assets - income paid to foreign held US assets.
Ex. interest payments to US owned Brazilian bonds - interest payment on German owned US treasury bonds.
Net transfer (tend to be unilateral)
Foreign aid > a debit to the current acct
Ex. Mexican migrant workers send money to family in mexico.
Capital/Financial accounts
Includes the purchase of both real and financial assets
Direct investment in US is a credit to capital account
Ex. Toyota factory in San Antonio
Direct invest by US firms/individual in a foreign country are debit to the capital account.
Ex. Intel factory in San Jose, Costa Rica
Purchase of foreign financial assets represent a debit to capital account.
The current account & capital account should zero each to her out.
If current account has a negative balance (deficit) then the capital account has a positive balance (surplus)
Official Reserve
foreign currency holding of the United States Federal Reserve System
When there is a balance of payments surplus the FED accumulates foreign currency and debits the balance of payments.
Active vs. Passive
the US is passive in its use of official reserves because our exchange rate stays the same
the people's republic of china is active in its use of official reserves.
Actively buys and sells dollar in order to maintain a steady exchange with the US

Unit 5 notes

Short Run AS

• Time is too short for wages to adjust to the price level 
• Workers may not be aware of changes in their real wages due to inflation and have adjusted their labor decisions and wage demands accordingly. 
• Nominal Wages: Amt. of money received per hour, day, or year
• Adjusted for inflation
• Sticky Wage: Nominal wage level set according to an initial price level and it does not vary.
• Will be stuck in the short run for a while

Price level	Wage level	Employment level	Implications
Keynesian: Fixed	Fixed	Flexible	Output depends on changes in employment
Intermediate: flexible	Fixed	Flexible	Output depends on change in price level and employment
Classical: flexible	Fixed	Fixed	Output depends on a change in price level

Long Run AS

• It has flexible wages and price levels
• off set each other
• Time is long enough for wages to adjust to price level
• if we have growth, capital stock gain and change in technology.

Phillips Curve

• Represents the relationship between inflation and unemployment. 
• Trade off between inflation and unemployment only occurs in the short run.

Long Run

• The long run curve occurs at the natural rate of unemployment
• represented by a vertical line
• there is no trade off in the long run, meaning the economy produces at full employment level
• Long run Philips Curve shift only if LRAS shifts
• At the natural rate of unemployment: structural, seasonal and frictional unemployment exist
• fewer worker benefits create lower natural rates
• Shift PPC outwards, LRPC will shift, otherwise it is vertical and stable

Short run

• Inverse relationship between inflation & unemployment.
• High inflation means lower employment
• Relevance to okun's law
• Since wages are sticky
• inflation changes
• moves the points on SRPC
• If inflation persist and expected rate of inflation rises, then the entire SRPC moves upward due to stagflation.  
• If inflation drop due to new technology or economic growth then SRPC moves downward
• Aggregate supply shock cause both rate of inflation & unemployment to inc. 
• Supply shock
• rapid and significant inc. in resource cost.

• Misery index
• combination of inflation & unemployment in any given year. 
• Single digit misery is good.
• LRPC: exist natural rate of unemployment, structural changes in the economy affect unemployment and shift LRPC

• Stagflation: when inflation/unemployment increase simultaneously

1. During 1946-1964 (baby boom)
2. Women's movement
3. Civil rights movement
4. Vietnam War ends
5. Oil embargo 1973 & 1979

• Disinflation: reduction in inflation rate from year to year. 
• occurs when AD declines.
• Deflation: general drop in the price level.

Supply Side Economics

• Belief that as AS curve determine level of inflation, unemployment, & econ growth.  
• To increase economy,  the AS curve will have to shift to the right which will have to benefit the economy first.
• Supply Side Economics focus more on marginal tax rate.
• marginal tax rate = amount paid on last dollar earned or additional dollar earned
• Lower taxes are incentives for businesses to invest in our economy. 
• Lowered taxes are incentives to increase savings & therefore create lower interest rates which will increase business investment.

Supply Side Economists support policies that promote GDP growth by arguing high marginal tax rate along with the current system of transfer payments, such as welfare and unemployment provide disincentives to work, invest and undertake entrepreneurial ventures.

• Referred to as Reaganomics
• Lower marginal tax rate to get U.S. out of a recession >  deficit. 
• Trade off between tax rates & govt. revenue is used to support supply side argument.  
• As tax rates increase from zero, tax revenue increase from zero to some maximum level and then declines.

3 criticism of the Laffer Curve:

1. Research suggests that impact of tax rates on incentives to work, invest, & to save are small.
2. Tax cut also increase demands which can fuel inflation & cause demand to exceed supply.
3. Where economy actually located on the curve is get to be determined.

Unit 4

Money is any assets to purchase any good or service

3 uses:

• Medium of exchange
• Unit of account: how to compare prices
• Store value: how money can be stored

3 types of money:

• Commodity money
• Has money within itself
• Salt
• Olive oil
• Gold
• Representative money
• Represents something of value
• An IOU
• Fiat money
• It is money because the government said so
• Paper currency
• Coins

6 characteristics of money

• Durability
• Portability
• Divisibility
• Uniformity
• Limited supply
• Acceptability

Money supply is the total value of financial assests available in the US economy

M1	M2
Liquid assets = east to convert to cash Cash Paper currency Coins Checkable deposits or Demand Deposits Travelers checks	M1 money + savings acct or money market account

Purpose of financial institutions

• Store money
• Save money
• Loan money
• most loan for credit cards/mortgages

4 ways to save money

• Savings
• Checkable accounts
• Money market account
• Certificate of deposit (CD)

Loans

• Banks operate on a fractional reserve system
• Which is where they keep a fraction of funds and loan out the rest

Interest rates

• Principle amount of money borrowed
• Interest: price paid for use of borrowed money
• Simple interest: paid on the principle
• Compound: paid on the principle + accumulated interest

Types of financial institutions

• Commercial banks
• Savings and loans
• Mutual savings banks
• Credit unions
• Finance companies

Investments

• Redirecting resources you'd use now for the future
• financial assets: claims on property or income of borrowers
• financial intermediary: institution that channels funds from savers to borrowers
• Purpose of these
1. Sharing risk, by diversification: spread investment to reduce risk
2. Providing information
3. Liquidity returns: amount investors receive above and beyond the sum of money invested

Bonds you OWN -- Stocks you LOAN

Bonds: loans or IOUs that represent debt that govt. or corporations must repay to an investor; a relatively low risk investment

• Coupon rate: interest rate the issuer pays the bond holder
• Maturity: time which payment to bond holder is due
• Par value: amount an investor pays to purchase an bond and that would be paid to investor at maturity
• Yield: annual rate of returns on a bond if bond is held to maturity

Time value of money

1. Is a dollar today worth more than tomorrow?
• Yes, because inflation topp. cost
• This is the reason for charging and paying interest

• Let V = future value of money
• P = present value of $
• r = real interest rate (nominal - inflation rate)
• n = years
• k = # of times interest is credited per year
• Simple interest formula: V = (1 + r) ^n * p
• Compound interest rate: V = (1 + r/k)^nk * p

FUNCTIONS OF THE FED

• issue paper currency
• set reserve requirements and hold reserves of banks
• lend money to bank and charge interest
• they are a check clearing service for banks
• act as personal bank for government
• supervise member banks
• control money supply in the economy

• Types of multiple deposit expansion: 
• Type 1: calculate initial change in excess reserves: amount single bank can loan form initial deposit
• Type 2: calculate change in loans in banking system. 
• Type 3: calculate change in money supply.
• Type 4: calculate change in demand deposit

How banks work

Assets	Liabilities + equities
Reserves Required reserves (RR): % required by FED to keep on hand to meet demand Excess Reserves (ER): % reserves over & above amt needed to satisfy minimum reserve ratio set by the FED	Demand Deposits ($ put in banks)
Loans to firms, consumers and other banks (earns to interest)	Checkable Deposits (CD's)
Bank property- if bank fails, you can liquidate the building/property	Loans from Federal Reserve & other banks
Loans to government-- treasury securities	Shareholders equity - to set up a bank, you must invest your own money in it to have a stake in the bank success or failure

• Creating a bank:
• transaction #4
• depositing reserves in a FED. reserve banks
• required reserves
• reserve ratio

Reserve ratio = commercial bank required reserve / commercial bank checkable deposit

• Reserve requirements
• Excess reserves
• Actual reserves - required reserves
• Required reserves
• checkable deposits * reserve ratio

Key principle:

• A single bank can create money (through loans) by the amount of excess reserves
• Banking system as a while can create money by a multiple (deposit on money multiplier) of the initial excess reserves.

Factors that weaken effectiveness of deposit multiplier

1. If banks fail to loan out excess reserves
2. if banks customers take their loans in cash rather than i nnew checking acct deposit, creates a cash/ currency drain

Money market

• inverse between money demand and the interest rates
• money demanded is downward sloping
• money supply is vertical
• fed buy bonds then interest rate is low
• decrease money supply by selling bonds

Fiscal	FED
Congress & the President	The Fed (Fed revenue bank)
Tax and spend	OMO (open market operation)
	Discount rate
	Federal fund rate
	Reserve requirements

• Federal fund rate: the interest rate that commercial banks charge each other for overnight loans
• Will always be opposite of bank reserves & money supply
• Money & bank increase, this decreases
• Prime rate: interest rate banks charge to their most credit worthy customers
• if higher than 4%. not prime rate

Loanable funds market

• market where savers and borrowers exchange fund (Qlf) at the real rate of interest
• demand for loanable funds or borrowing comes from households, firms, government and the foreign sector
• the demand for loanable funds is infact the supply of bonds
• supply of loanable funds is also the demand for bonds

Changes in demand for loanable funds

• Demand for loanable funds = borrowing (i.e supply bond)
• more borrowing = more demand for loanable funds shifts to the right
• less borrowing = less demand for loanable funds shifts to the left
• Ex. Govt. deficit spending = more borrowing
• Less investment demand = less borrowing, ir decrease

Changes in supply

• Supply of loanable funds = saving
• more saving = mor supply of loanable funds, shift to the right
• less saving = less supply of loanable funds, shift to the left
• Ex. Govt. budget surplus = more saving = more supply of loanable funds
• Decrease in consumer MPS = less saving = less supply of loanable funds

March 29th Video Response

Video #1:
     This video sought to teach us the basics of the money market. Commodities are basically goods that serve a purpose and representative money represents the quantity of precious metal and fiat money does not represent anything but the promise from the government that the money does have value. The functions of money include becoming a medium of exchange, which basically means it is through money that exchanges happen, money as a store of value and being a unit of account. (p > worth (quality)).

Video #2:
     Though there is a difference in labels, money market graphs are very similar to supply and demand graphs in their concepts. When the price is high, the demanded is high, when the interest rate is low, people have an incentive to borrow more. The supply of money is fixed and set by the FED, and it doesn't move unless the FED does so. When you increase demand, more pressure is put on interest rates. Quantity stays the same because supply is vertical, nothing can impact it. If they'd like to bring interest rates down, they'd have to increase money supply.

Video #3:
     The FED has two types of Monetary policy: Expansionary policy (easy money) and Contractionary policy (tight money). Under easy money, required reserves decrease in an effort to increase spending to battle recession and under tight money, required reserves increase in an effort to decrease spending to battle inflation. Discount rate isn't used very often as even if they have the incentive, it isn't guaranteed banks will comply and accept what is given. To expand the money supply, the FED buys bonds (expansionary), by doing this, money supply increases. The contract the money supply, the FED sells bonds (contractionary) and in turn reduces money supply. The Federal Funds rate i the rate at which banks borrow from one another.  

Video #4:
    Loanable funds is basically money that is available in banks for people to borrow. The loanable funds graph follows the basics of the previous graphs, but in this case, quantity stands for quantity of loanable funds and supply is upward sloping. Supply is dependent on savings As you increase demand in both the money market graph and loanable funds graph, interest rates increase. During a deficit, the government demands money in order to spend it.

Video #5:
     A key point in the money creation process is that banks create money by making loans. In a banking system, you'd multiply your excess reserves by your money multiplier. To get the money multiplier, you'd write it as 1/RR, 1 over the reserve ratio. An assumption of no excess reserves would reduce your total amount. To get the initial increase, you'd multiply the loan by the money multiplier.

Video #6:
     The equation of exchange follows the formula of MV=PQ, where M is the amount of money in the economy and V is the velocity of the money, it is stable and relates to the GDP expenditures. P is the average price of goods and Q serves as the total quantity or volume, this ties in with GDP income. A change in money will cause a change in price, just as the supply and demand graphs. Ultimately they are all related and with the shift of one side, the other will shift in response.

Unit 3 notes

Aggregate demand (AD)

• Shows the amount of real GDP that the privat, public and foreign sector collectively desire to purchase at each possible price level.
• The relationship between price level and level of real GDP is inverse
• Price level increases, output increases

Real balances effect

• Based on purchasing power
• High price, households and businesses cut on output purchase
• Low, more affordable

Interest rate effect

• High price level increases interest rate which tends to discourage investment
• Low price level decreases interest rate which tends to encourage investment

Foreign purchases effect

• High price level increases demand for relatively cheap imports 
• Low price levels increase foreign demand for cheaper US exports

What causes shifts in AD?

• Two parts to a shift in AD
• Change in C, Ig, G, Xn
• multiplier effect that produces a greater change than the original change in the 4 components
• An increase in AD would shift to the right, and the opposite if it were to decrease.

Consumption:

• Household spending affected by:

1. Consumer wealth
• More wealth, more spending (AD shifts to the right)
• Less wealth, less spending (AD shift to the left)
2. Consumer expectations
• Positive expectations = more spending (AD shift to the right)
• Negative expectations = less spending (AD shift to the left)
3. Household indebtedness
• Less debt = more spending (AD shift to the right)
• More debt = less spending (AD shift to the left)
4. Taxes
• Less taxes = more spending (AD shift to the right)
• More taxes = less spending (AD shift to the left)

Gross Private Consumption

• Investment spending sensitive to:

1. The real interest rate
• Low real interest rte= more investment (AD shift to the right)
• High real interest rate = less investment (AD shift to the left)
2. Expected returns
• Higher expected returns = more investment (AD shifts to the right)
• Lower expected returns = less investment (AD shifts to the left)
• Expected returns are influenced by:
• expectations of future probability
• technology
• degree of excess capacity (existing stock of capital)
• business taxes

Government spending

• More government spending (AD shift to the right)
• Less government spending (AD shift to the left)

Net exports

1. Exchange rate
• Strong $ = more imports, fewer exports (AD shift to the left)
• Weak $ = less imports. more exports (AD shift to the right)
2. Relative income
• Strong foreign economies = more exports (AD shift to the right)
• Weak foreign economies = less exports (AD shifts to the left)

Aggregate Supply

The level of Real GDP (GDPR) that firms will produce at each price level (PL)

Long Run v. Short Run

• Long run: time where input prices are flexible and adjust to change in price level
• level GDP supplied is independent of the price level
• Short run: time where input prices are sticky and don't adjust to change in price level
• level of GDP supplied is directly related to price level

Long run AS

• LRAS marks level of full employment in the economy (analogous to PPC)
• because input is completely flexible in the long run, changes in price level do not change firms real profits and so don't change firms level of output
• Meaning LRAS is vertical at the economies level of full employment
• SRAS is upward sloping because input prices are sticky

Remember

1. No matter whether its a decrease in supply or demand, it will always shift left
2. If it increases it will shift right

Per-unit production cost

• To get per-unit production cost = total input cost/total output
• The per-unit production cost is the key in understanding shifts

Determinants of SRAS:

• Input price
• Productivity
• Legal institutional environment

1. Input prices
• Domestic Resource prices
• wages (75% of all business prices)
• cost of capital
• raw materials (commodity prices)
• Foreign resource power
• Strong money = low foreign resource prices
• Weak money = high foreign resource prices
• Market power
• monopolies and cartel that control resources and control prices of those resources
• an increase in resource price shifts SRAS to the left
• a decrease would shift it to the right
2. Productivity
• Productivity = total output/total inputs
• More productivity = low unit production cost (AS shift to the right)
• Less productivity = high unit production cost (AS shift to the left)
3. Legal institutional enviroment
• Taxes and subsidies
• Taxes ($ to the govt.) on business increase per-unit production cost (AS shift to the left)
• Subsidies ($ from the govt.) to business reduce per-unit production cost (AS shift to the right)
• Government regulation
• Government regulation creates a cost of compliance (AS shift to the left)
• Deregulation reduce compliance cost (AS shift to the right)

Interest

• Full employment equilibrium exist where AD intersects with SRAS and LRAS at the same point
• Recessionary gap: exist when equilibrium occurs below full employment output
• AD shift to left with recessionary gap
• Inflationary gap: when equilibrium occur beyond full employment output
• AD shift to right with inflationary gap
• Unemployment increase, deflation decreases

Interest rate and investment demand

Investment: your expidentures

• New plants
• Capital equipment (machinery)
• Technology (hardware and software)
• New homes
• Inventories

Expected rates of return

• How business makes investment decisions
• cost benefit analysis
• How businesses determine benefits
• Expected rate of return
• How businesses count cost
• interest cost
• How to determine the amount of interest
• compare expected rate of return to interest cost
• if expected cost > iterest then invest, if not, then don't invest

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

• What is the difference?
• Nominal is the observable rate of interest
• Real subtracts out inflation only known to ex post facto
• How to compute real interest rate?
• r% = i% - π%
• What then determines cost of investment  decision?
• real interest rate (r%)

Investment demand curve (ID)

• is downward sloping because when interest rate is high people don't want to pay, few investments profitable

1. Cost of production
• Low cost shit ID to the right
• High cost shift ID to the left
2. Business taxes
• Low business taxes shift ID to the right
• High business taxes shift ID to the left 
3. Technological change
• New technology shift ID to the right
• Lack of technology shift ID to the left
4. Stock of capital
• Economy low on capital, ID shift to the right
• More capital, ID shifts to the left
5. Expectations
• Positive expectations shift ID to the right
• Negative expectations shift ID to the left
6. Long run
• Always vertical at full employment
• Represents point on an economy's production possibilities curve (PPC)
• Doesn't change as price level changes
• Only factors which would change it would be what  shifts the PPC outward
•  Δresources
•  Δtechnology
•  Δeconomic growth

Three Schools of Economics

Classical	Keynesian	Monetary
Savings(leakage) = investment injection	Savers ≠ investors	Allen Greenspon
Adam Smith	John Maynard	Ben Bernank
John B. Say
David Ricardo
Affard Marshall

• Classical
• Competition is good
• Adam Smith: invisible hand >> don't need government intervention, run without it
• Say's law
• supply creates own demand
• As determine output
• In the long run, economy will balance at FE
• The economy is always at or close to FE
• AS=AD at full employment equilibrium
• Trickle down effect
• Help rich first, everybody else later
• Savings increase with interest rate
• save more at high interest, low interest rate you spend
• Prices and wages flexible downward
• Foster Laissez faire >> don't need the government
• Keynesian
• Competition is flawed
• AD is key, not AS 
• AD determines own output, demand create own supply
• Leaks cause constant recessions
• savings cause recessions
• Savings and investors save and invest for different reasons
• savings inverse to interest rate
• Ratchet effect and sticky wages block Say's law
• Prices and wages inflexible downward
• Since there is no guarantee of FE, in the long run, we are all dead
• The economy is never close to or at FE
• Use fiscal policy, add stabilizers, use expansionary and contract policy
• Monetary
• Fine tuning needed
• Voters won't allow contract. actions
• Congress can't time policy actions
• Institute easy money and type money
• Change regulation reserves if needed
• Buy and sell bond via open market operations
• Use interest rate to change discount and federal fund rates

Consumption and Savings

• Two choices; with disposable income, households can either:
1. Consume (spend money on goods and services)
2. Save (not spend money on goods and services)
• Disposable income (DI)
• Income aft taxes or net income
• DI = gross income - taxes
• Consumption
• Household spending
• Ability to consume constrained by
• amt of disposable income
• propensity to save
• Do households consume if DI = 0?
• autonomous consumption
• Dissaving
• APC = C / DI = % DI that is spent
• Saving
• Household not spending
• Savings constrained by
• amt of  disposable income
• the propensity to save
• Do households save if DI = 0?
• No
• APS = S/DI = % that is not spent
• Calculations
• APC + APS = 1
• 1 - APC = APS
• 1 - APS = APC
• APC > 1 = Dissaving
• -APS = Dissaving

MPC and MPS

• Change in consumption/change in DI
• Marginal propensity to save and marginal propensity to consume
• ΔS/ΔDI
• % of every extra dollar earned that is saved
• MPC + MPS = 1
• 1 - MPC = MPS
• 1 - MPS = MPC
• Spending multiplier effect
• initial change in spending (C, Ig, G, Xn) causes larger change in Aggregate spending or Aggregate demand
• Multiplier = Δ in AD/C, Ig, G, Xn
• Why does this happen?
• Expenditures and incomes flow continuously which sets off a spending increase in the economy
• Spending multiplier can be calculated from MPC or MPS
• Multiplier = 1/1-MPC or 1/MPS
• Multipliers are positive (+) when there is an increase in spending and negative (-) with a decrease
• Tax multiplier (note it is negative)
• When government taxes, multipliers work in reverse because money is leaving the circular flow
• -MPC/1-MPC or -MPC/MPS
• If there is a tax cut, then mulltiplier (+), because more money is in the circular flow

Fiscal Policy

• Change in expenditures or tax revenues of federal government
• 2 tools
• Taxes (increase or decrease)
• Spending (increase or decrease)
• Deficits, surpluses, & Debt
• Balanced budget
• Revenue=Expenditures
• Budget deficit: spending more than what is being brought in
•  Revenue<Expenditures
• Budget surplus: bringing in more than what spent out 
• Revenue>Expenditures
• Government debt
• sum of all deficits – summation of all surplus
• Government must borrow money when in budget deficit
• Borrow from:
• Individuals
• Corporation
• Financial institutions
• Foreign entitled foreign government

Fiscal policy

• Two options:

1. Discretionary (action)
• expansionary fiscal policy (think deficit)
• contractionary (think surplus)
2. Non-discretionary (no action)

Discretionary v. Automatic

• Discretionary
• Increase or decrease government spending/taxes in order to return the economy to full employment
• Involves policy makers in response to economic problems
• Automatic
•  Unemployment compensation and marginal tax rates are examples of automatic policies that mitigate recession and inflation effects
• Takes place without policy makers having to respond to current economic problems

• Contractionary fiscal policy
• policy designed to decrease AD
• strategy for combating inflation
• decrease govt. spending and increase taxes
• Expansionary fiscal policy 
• policy designed to increase AD
• strategy for increasing GDP
•  strategy for combating recession and reducing unemployment
• increase govt. spending and decrease taxes.  
• Automatic or built-in stabilizers: (non-discretionary)
• anything that increases the governments budget deficit during a recession and increases its budget surplus during inflation without requiring action from policy makers
• Transfer payments:
• Welfare checks
• Unemployment checks
• Social security
• Food stamps
• Corporate dividends 
• Veteran's benefit
• Progressive tax system:
• avg. tax rate (tax revenue/GDP) rises w/ GDP 
• Proportional tax system
• avg. tax rate remains constant as GDP changes 
• Regressive tax system
• avg. tax rate falls w/ GDP

Unite 2 Notes

                                                                           GDP

1. Domestic Value (GDP): The total dollar value of all goods and services produced within a country's border within a given year.
2. Gross National Product (GNP): The total value of all final goods and services produced by Americans within a year.
• An American making a product in Bangladesh will go to our GDP and Bangladesh's GNP.

        What is included in GDP? 

          C + Ig + G + Xn = GDP

• C- Consumption: 67% of economy spent; has to be a final good or service
• Ig- Gross Domestic Private Investment: factory equipment maintenance, new factory equipment, construction of housing, unsold inventory, and products built in a year.
• G- Government spending
• Xn- net export: Export-Import

        What is excluded in GDP?

• Non-market activities: Volunteering, family work, illegal drug dealing
• Intermediate goods: Goods and Services purchased for resale or for further processing or manufacturing
• Not counted to avoid multiple or double counting
• Used or second hand goods: Counted first year purchased
• Financial Transaction
• Stocks
• Bonds
• Real estate
• Gifts or Transfer Payments
• Public: Recipient contributes nothing to current production
• Ex. Welfare pay, Social Security Numbers
• Private: Produce no output; transfer fund from one individual to another
• Ex. Scholarship

1. Expenditure approach: Sum of all domestic expenditures made on a final good
• C + Ig + G + Xn = GDP
2. Income approach: Add up all income earned by households and firms in a single year
• W + R + I + P + Statistical Adjustments = GDP
• W: wages
• R: rent
• I: interest
• P: profit (proprietor's income)

HELPFUL FORMULAS: 

1. Budget: Gov. purchases of goods & services + Gov. transfer payments - Gov. tax & free collection
• If the total is positive(+), it is a deficit
• If the total is negative (-), it is a surplus
2. Trade: export - import
3. GNP: GDP + net foreign factor payment
4. NNP (net national product): GNP - depreciation
5. NDP (net domestic product): GDP - depreciation
6. National income: GDP - indirect business taxes - depreciation - net foreign factor payment
• OR compensation of employees + rental income + interest income + proprietor's income + corporate profits
7. Disposal personal income: National income - personal household taxes + Gov. transfer payment
8. Ig (Gross Domestic Private Investment): net domestic investment - consumption of fixed capital (depreciation)

NGDP and RGDP

1. Nominal GDP (NGDP): Value of output produced in current prices
• Price x Quantity
• Can increases year to year if either output or prices increase.
2. Real GDP (RGDP): Value of output produced in constant or base year prices
• Base Price (earliest year) x Quantity
• Can increase year to year only if output increases
3. Output is measured by Quantity
4. Adjust for Inflation, take in base year prices

Price index and Inflation

The Price index measures inflation by tracking changes in price of a market basket of goods compared with a base year

• Price Index
• Price of market basket in current year   x 100
•             Price of market basket in base year   

• GDP Deflator
• Price index used to adjust from nominal GDP to real GDP
• In base year, GDP is 100, after base year GDP is greater than 100
• Years before base year, GDP deflator is less than 100
• Calculate with the following formula
• Nominal GDP  x 100
•  Real GDP
• How to calculate Inflation
•  New GDP deflator - Old GDP deflator   x 100
•                     Old GDP deflator

1. Inflation: Rise in general prices. 
• Standard  rate 2% - 3%
• Inflation rate: Measure the percentage increase in the price level overtime.

• Key indicator of economy's wealth.
• Deflation: decline in general price level.
• Disinflation: occurs when deflation rate itself declines.  
• Consumer price index (CPI): measures inflation by tracking yearly prices of a fixed basket of Consumer goods and services. in addition, CPI changes in cost of living and price level.

       How to solve Inflation

1. Finding inflation rate using market basket data
•  current year market basket value - base year market basket value  x 100
2.                       base year market basket value 
3. Finding inflation rate using price index:
• current year price index - base year price index   x 100
•  base year price index
4. Estimate inflation using rule of 70
• Used to calculate the number of years it will take for the price level to double at any given rate of inflation.
• Years needed to double inflation = 70/Annual inflation rate
5. Determine Real Wages
• Real Wages: Nominal Wages/Price level  x 100
6. Finding Real interest rate
• Nominal interest rate - Inflation premium
• Cost of borrowing or lending money that is adjusted for inflation
• Always expressed as a percentage
7. Nominal interest rate
• Unadjusted cost of borrowing or lending money

      Causes of Inflation

• Demand Pull Inflation
• Caused by and excess of demand over output that pulls prices upward
• Cost Push Inflation
•  Caused by a rise in per unit production cost due to increasing resource cost

     Effects of Inflation

• Anticipated Inflation
• It was expected it to happen
• COLA added to pay, wages are adjusted
• Unanticipated Inflation
• What happens is unexpected
• One morning, almost all workers in a factory are fired

Who does it hurt and who does it help?

1. Helps
• Borrowers: Their debt will be repayed with cheaper dollars than what was loaned out
• Fixed Contract
2. Hurts
• Fixed income
• Retirement, Social security
• Savers
• Lenders/creditors

Unemployment

• Percentage of people who do not have jobs but are in the labor force
• The labor force is the number of people in a country that are classified as either employed or unemployed
• # of Unemployed                             x 100
• # of unemployed + # of employed
• Those not in the labor force include
• Kids
• Military Personnel
• Mentally insane
• Incarcerated
• Retired folks
• Stay at home parents
• Full time students
• Discouraged Workers
• Full employment: Occurs when no cyclical unemployment is present in the economy
• "Natural Rate of employment" - known as NRU
• 4-5%  is the desired goal
• Why is unemployment good?
• Less pressure to raise wages
• More workers available for future expansions
• Why is unemployment bad?
• Not enough consumption
• Too much poverty
• Too much Government assistance needed
• Okun's Law:
• for every 1% of unemployment above the NRU, it causes a 2% decline in real GDP.

Employment Statistics

1. Frictional unemployment
• People between jobs
• Choosing new opportunities, lifestyles and new education
2. Seasonal unemployment
• Waiting for the right season to conduct your trade
• Ex. Bus driver, Life guard, Construction worker
3. Cyclical unemployment
• Down turns in business cycle, bad for society and the individual if recession or trough.
4. Structural unemployment
• Lack of Skills, a decline in the industry or technology changes
• Ex. Type writer in computer age

Circular flow model

• Represents transactions in an economy
• Goods and services flow clockwise

2 markets

• Resource/Factor: Place where households sell resources and buisnesses buy resources
• Product market: Place where goods and services ate produced and bought abd sold to households

3 actors in the  economy

1. Households 

2. Government 

3. Firm

Market economy is a free market

Unit One

1. Macroeconomics vs. Microeconomics
• Macroeconomics is the study of the major components of the economy and deals with the functioning of the economy as a whole.
• Microeconomics is the study of how households and firms make decisions and how they interact in markets.
• The two fields may seem different, but they both compliment each other and with certain situations, find themselves overlapping one another.
2. Positive economics vs. Normative economics
• Positive economics is fact based and are claims that attempt to describe the world as is. For example: The Australian stock market has boomed in recent years.
• Normative economics is opinion based and claims that attempt to describe how the world should be. For example: The government should raise minimum wage.
3. Needs vs. Wants (Scarcity vs. Shortage)
• Needs: Basic requirements for survival (Ex: Food, Water, Shelter)
• Wants: Desires of the citizens which are often broader than their needs. (Shopping, TV)
• Scarcity: Most fundamental economic problem facing all societies. Satisfying unlimited wants with limited resources. Is permanent. (Ex: Clean water, oil)
• Shortage: Quantity demanded is greater than the quantity supplied. Is temporary. (Ex: no juice at Walmart for the day)
4. Goods vs. Services
• Goods: Tangible commodities
• Consumer goods: goods intended for final use by the consumer (Ex. Chocolate, Ladies goodies)
• Capital goods: Items used to produce another good
5. Factors of Production
• Land (Territory over which rule is exercised)
• Labor (Physical: Manmade objects to make other goods)
• Capital (Wealth in form of money)
• Entrepreneurshipb  (Innovative and a risk taker)
6. Trade offs
• Alternatives given up when choosing one possible good over another.
7. Opportunity Cost
• The most desirable alternative lost by making a decision
• No matter what we do, there will always be an opportunity cost. 
• For example, choosing to watch a Disney movie over studying for your AP Economics test the very next day. Because you chose to watch a Disney movie, you gave up the decision to study.
• Free lunch isn't actually free
• There will always be opportunity costs
8. Guns or Butter
• Based on the decision between either Military spending or Agriculture.
9. Production Possibilities Graph

• Production Possibilities Frontier (PPF)/ Production Possibilities Curve (PPC)
• Shows alternative ways to use an economy's productive resources. 
• What does each point represent?
• Points on the line are efficient (A & B)
• Points outside the line are unattainable (C)
• To become unattainable, there would need to be an advancement in technology or economic growth of some form.
• Points inside the line are inefficient and underutilized (D)
• Can be due to unemployment, underemployment, war, famine or a decrease in population 
• Points on both the inside and on the line are attainable (A, B & D)
• Key Assumptions
1. Two goods are produced
2. Fixed resources (land, labor, capital,)
3. Fixed state of technology
4. No international trade
5. Full Employment
• Full employment (FE): There is no 100% employment and is not 100% productive
• FE ~ 40% unemployment ---- FE ~ 80% factory capacity
10. Demand
• The quantities that people are willing and able to buy at various prices.
• The Law of Demand states there is an inverse relationship between price and quantity demanded. In other words, as price increases, quantity decreases and vice versa.
• A change in quantity demanded is caused by a change in prices. What else causes a change in demand?
• Change in buyers taste (advertising)
• Change in buyers (population)
• Change in income
• Normal goods: Goods buyers buy more of with an increase in income
• Inferior goods: buy less when income rises
• Change in price of related goods
• Substitute goods: serve roughly the same purpose to buyers
• Complimentary goods: goods often consumed together (Shoes & Socks!)
• Change in expectations
11. Supply
• The quantities that producers/sellers are willing and able to produce/sell at various prices
• The Law of Supply states there is a direct relationship between price and quantity. As quantity increases, price decreases.
• A change in quantity supplied is caused by a change in prices. What else causes a change in supply?
• Change in weather
• Change in technology
• Change in cost of production
• Change in taxes or subsidies (money provided by the govt.)
• Change in number of sellers
• Change in expectations.
12. Equilibrium
• Point at which the supply curve and the demand curve intersect. At this point, the economy is using all of its resources efficiently
13. Surplus
• Quantity Supplied > Quantity Demanded
14. Shortage
• Quantity Supplied < Quantity Demanded
15. Price Ceiling

• Government imposed price control on how high a price can be charged for a product or service.
16. Price Floor
• Government imposed price control on how low a product or service can be charged.
17. Calculating Supply Problems
• Totals Revenue = P x Q
• Marginal revenue
• Additional income from selling one more unit of a good
• Fixed Cost
• Cost that does not change no matter how much is produced 
• Ex; Rent, Mortgage, Insurance
• Variable Cost
• Fluctuates and changes
• Based on how much is produced
• Ex; Electric, gas and phone bills
• Important formulas include
• MC = (new TC - old TC)
• TC = TFC + TVC
• AFC = TFC/Q
• AVC = TVC/Q
• ATC = AFC + AVC ------ OR ------ TC/Q
18. Finally, Business Cycles!
• Main 4 phases
• Expansionary (Growth): Real output in the economy is increasing, unemployment rate is declining
• Peak: Real output is at its highest point
• Contractionary phase: Real output is decreasing, unemployment rate is rising. 
• The average cycle is 6 years
• A bulk of the cycle is in the growth stage
• asts anywhere from 14 months to a year
19. Price elasticity of demand: Tells how drastically buyers will cut back or increase their demand for good when prices rise or fall.

• Elastic demand: When demand changes greatly due to a change in price (your wants--- E>1
• Inelastic demand: Demand won't change even if price changes (Substitute: gas, milk, salt, your needs--- E <1
• Unit elastic: E= 1 (The perfect ideal situation)

1. For calculating % change in quantity: new quantity - old quantity / old quantity
2. % change in price: new price - old price / old price
3. Price elasticity % demand (PED): % change in quantity / % change in price