Unit 4 Money

 
Money is any asset that can be used to purchase goods and services.
 

3 uses of money

- As a medium of exchange (using it to determine value
- Unit of account is used to compare prices
- Store of value (where some people hide their money)

3 types of money

- Commodity money (has value within its self)
- Representative money (represents something of value)
- Fiat money (money because Government says so)

 

6 characteristics of money

- Durability
- Portability
- Divisible
- Uniformity
- Limited Supply
- Acceptability

Money Supply is the total value of financial assets available in the US economy.

M1 Money:

Involves Liquid Assets (easily converted to cash)
- coins
- checks
- currency
- travel checks

M2 Money:

It is not as liquid as M1
- savings account
- Money market account
3 purposes of financial institutions
- Store money
- Saved money
- Loan money
 

Two reasons why they loan money

- Credit cards
- Mortgages

Four ways to save

- Savings account
- Checking account
- Money market account
- Certificate of deposit


Loans: Banks operate on a fractional reserve system which means they keep a fraction of the funds and loan out the rest.
Interest rates
- Principle is amount of money borrowed
- Interest is the price paid for use of borrowed money
   ■ Simple Interest is paid on the principle
   ■ Compound interest is paid on the principle plus accumulated interest

Formula for simple interest:

I equals P times R times T over 100
T equals I times 100 over P times R
P equals I times 100 over R times T
R equals I times 100 over P times T

 

Types of financial institutions

- Commercial bank
- Savings and loans institutions
- Mutual savings bank
- Credit unions
- Finance Companies

 

Investment:

Redirecting resources. Consume now for the future.
Financial Assests: are claims on property and income of borrower
Financial Intermediaries: institutions that channel funds from savers to borrowers. 3 purposes of financial intermediaries
- Share risks. Through diversification. Where spreading out investment to reduce risk.
- Provide information
- Liquidity (Returns) money investors above and beyond the sum of money that was initially invested

Bonds are loans that represent debt that the government or a corporation must repay to a investor. Generally low risk.

3 components of a bond

- Coupon rate is the interest rate that a bond insurer will pay to a bond holder
- Maturity is the time in which payment to a bond holder is due
- Par value (principle) amount that an investor pays
- Yield is the annual rate of return on a bond if the bond were held to maturity

Unit 3 Aggregate Supply

Aggregate Supply.

The LRAS marks the level of full employment in the economy. (Analogous to PPC)

Because input prices are completely flexible in the long run changes in price level do not change firms real profit and therefore do not change firms level of output. This means the LRAS is at the economy's level of full employment. 

LRAS GRAPH

Because input prices are sticky in the short run, the SRAS is upward sloping.

 

SRAS GPAPH

An increase in SRAS is seem as a shift to the right. SRAS →
A decrease in SRAS is seem as a shift to the left. SRAS ←

 

The key to understanding shifts in SRAS is per unit cost of production.
Per unit production cost equals total input cost.

Determinants of SRAS
- input prices
- productivity
- legal institutional environment

Input prices.
-Domestic resource prices
   ■wages
   ■cost of capital
   ■raw materials
-foreign resource prices
   ■strong $ equals lower foreign resource prices
   ■weak $ higher foreign resource prices
-market power
   ■monopolies and cartels that control resources control the price of those resources
-increasing in resource prices
-decrease in resource prices

Productivity
 

Equation is total output over total inputs

More productivity is lower unit production cost

Lower productivity is higher unit production cost

Legal institutional environment.
-taxes and subsidies
   ■taces on business increase per unit production cost
   ■subsidies to business reduce per unit production cost
-Government regulation
   ■government regulation creates a cost of compliance SRAS ←
   ■deregulation reduces compliance cost. SRAS →

Unit 3 Aggregate Demand

Aggregate Demand. AD

-Shows the amount of real GDP that the private, public, and foreign sector collectively desire to purchase at each possible price level. 

Three reasons AD is downward sloping. 

Real Balances Effect 

-when the price level is high households and businesses cannot afford to purchase as much output. 

-when the price level is low households and businesses can afford to purchase more output. 

Interest rate effect

-a higher price level increases the interest rate which tends to discourage investment

-a lower price level decreaes the interest rate which tends to encourage investment

Foreign purchases effect

-a higher price level increases the demand for relatively chaper imports

-a lower price level increases the foreign demand for relatively cheaper US exports

Shifts in Aggregate demand. AD

-There are two parts to a shift in AD

    ■

    ■

Increases in AD equals AD →

 

Consumption

-Household spending is affected by 

 ■consumer wealth

   ● more wealth is more spending →

   ●less wealth is less spending ←

-Consumer expectations

  ● positive expectations is more spending →

  ●negative expectations is less spending ←

-Household indebtedness

   ●less debt is more spending →

   ●more debt is less spending ←

-Taxes

   ● less taxes is more spending →

   ● more taxes is less spending ←

Gross private investment

●Investment spending is sensitive to:

  -The real interest rate

     ○Lower real interest rate is more investment

     ○higher real interest rate is less investment

-Expected Returns

       ○higher expected returns is more investment

       ○lower expected returns is less investments

       ○ expected returns are influenced by expectations of future profitability, technology, degree of excess capacity, business taxes 

  Government spending

-More government spending AD shifts right

-Less government spending AD shifts left

Net Exports are sensitive to:

-Exchange rates (international value of $)

Strong $ is more imports and fewer exports is AD shifting to the left

Weak $ is fewer imports and more exports is AD shifting to right

-Relative Income

Strong foreign economies is more exports is AD shifted to the right

Weak foreign economies is less exports is AD shifted to the left

Unit 3 Savings and Consumption

Disposable Income

-Income after taxes or net income
-DI = Gross Income - Taxes

2 choices
- With DI households can either
  □consume
  □save

 

Consumption

-Household Spending
-The ability to consume is constrained by
   □the amount of disposable income
   □the propensity to save
-Do households consume if DI=0?
   □autonomous consumption
   □dissaving

APC = C/DI = percent DI that is spent

 

Saving

- Household NOT spending
- the ability to save is constrained by
   □ the amount of disposable income
   □ the propensity to consume
-Do households save if DI = 0
   □No
-APS = S/DI = percent DI that is not spent

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

 

MPC AND MPS

- Marginal propensity to consume
  ■ C OVER DI
  ■ percent of every extra dollar earned that is spent
- Marginal prosperity to save
  ■S over DO
  ■ percent of every extra dollar earned that is saved

MPC PLUS MPS = 1
1- MPC = MPS
1- MPS = MPC

 

The spending multiplier effect

-the initial change in spending causes a larger cjange in Aggregate spending or aggregate demand
- Multiplier = change in AD over change in spending

 

The spending multiplier effect

Why it happens? Expenditures and income flow continuously which sets off a spending

Calculating the spending multiplier
Multiplier is 1 over 1-MPC OR 1 OVER MPS

Multipliers are positive when there is an increase in spending and negative when there is a decrease

Calculating the tax multiplier

- when the government taxes, the multiplier works in reverse
-Why?  Because now money is leaving the circular flow
- Tax Multiplier = - MPC OVER 1-MPC OR -MPC over MPS
- If there is a tax cut then the multiplier is positive because there is now more money in the circular flow.

Unit 3 Schools of Economics

3 schools of Economics-

Classical school: 

Key Individuals: Adam Smith, John B. Sey, David Ricardo, and Alfred Marshall.
 

They say Competition is good. Invisible hand means market runs itself. No Government intervention. Says Law says that supply creates its own demand. The economy is always close to or at full employment. In the long run the economy will balance at full employment. Triple down effect helps the rich first then everyone else. Savings is a leakage and investment is an injection. Savings increase with interest rate. Prices and wages are flexible downward.  AS determines the output. AS equals AD at full equilibrium. 

Keynesian school:

Key Individuals: John Maynard Caynes, Congress.

John says AD is Key not AS, demand creates its own supply, competition is flawed. Savings does not equal investment. Savings are invert to savings rate. Leaks and savings causes constant recession. Ratchet effects ans sticky wages block says law. The economy is not always close to or at full employment. Use fiscal policy. Will add stabilization. Use expansionary and contractionary. 

Monetary school: 

Key Individuals: Allen, Ben Bernanke. 

Congress can't time the policy options. Voters won't allow contractionary options. Easy money and tight money. Change the required reserves if needed. Buy or sell bonds through open market operations. Use the interest rate to change the discount rate and federal fund rate.

Unit 3 Fiscal Policy

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

2 tools of fiscal policy
1. Taxes - gov can increase or decrease taxes
2. Spending - gov can increase or decrease spending

Deficits, Surpluses, Debt
- Balanced budget
  Revenues equals expenditures
- Budget deficit
  Revenues is less than expenditures
- Budget Surplus
  Revenues is greater than expenditures
- Government Debt

- Government must borrow money when it runs a budget deficit
- Government borrows money from individuals, corporations, financial institutions, foreign entities, foreign governments. 

Three options in Fiscal policy
- Discretionary fiscal policy
  Expansionary fiscal policy
  Contractionary fiscal policy

Discretionary v. Automatic fiscal policies
Discretionary is increasing or decreasing  gov spending and or taxes in order to return to the economy to full employment. Discretionary policy involves policy makers doing fiscal policy in response to an economic problem

Automatic unemployment compensation and marginal tax rates are examples of automatic policies that help mitigate the effects of recession and inflation.

Contractionary vs. Expansionary fiscal policy
Contractionary fiscal policy- policy designed to decrease aggregate demand
   - Strategy for controlling inflation
Expansionary fiscal policy
Policy designed to increase aggregate demand
    - Strategy for Increasing GDP, combats a recession, reduces unemployment

Expansionary increases government spending and decrease taxes

Contractionary decrease government spending and increase taxes

Automatic or built in stabilizers is anything that increases the governments budget deficit during a recession and increases it's budget surplus during inflation without requiring explicit action by

 

Transfer payments
1. Welfare checks
2. Food Stamps
3. Unemployment checks
4. Corporate dividends
5. Social security
6. Veteran's security

Progressive tax system
   Average tax rate rises with GDP
Proportional tax system
   Average tax rate remains constant as GDP changes
Regressive Tax system
   Average tax rate falls with GDP

Unit 2 Notes

GDP (Gross domestic product) 

is total dollar value of all final goods and services produced within a country's borders within a given year. 

GNP (Gross national product)

 is a measure of what its citizens produce and weather they produce those items within it's borders

DIFFERENCE BETWEEN GDP AND GNP

Whats included in GDP:

Consumption+ Gross private domestic investment+Government spending+Net Exports

 

 

Consumption takes up 67 percent of economy. "Final goods and services"

Gross private domestic investment. 

1. Factory equipment maintenance

2. New factory equipment

3. Construction of housing

4. Unsold inventory of products built in a year

Government Spending

includes all government consumption, investment, and transfer payments.

 

Net exports 

is the amount by which foreign spending on a home country's goods and services exceeds the home country's spending on foreign goods and services.

 

What's not included:

1. Used or second-hand goods

2. Intermediate goods (goods and services that are purchased for resale or for further processing or manufacturing)

3. Non-market activities

Ex. Babysitting. Volunteering. Illegal drug sale. Trading. Borrowing

4. Financial transactions. Stocks, bonds

5. Gifts or transfer payments. (Public and private)

Private produces no output. Simply transferring funds from one individual to another. Ex Scholarship, Christmas gift. 

Public where recipients contribute nothing to the current production

Ex. Social security, welfare payments

 

 

Nominal GDP

is the value of output produced in current prices. It can increase from year to year if either output or price increase.

Real GDP

 is the value of output produced in base year or constant prices. Is adjusted for inflation. Can increase from year to year only if output increases.

If base year is not inferred then it is always the earliest year.

Price index

 is a measure of inflation by tracking changes in a market basket of goods compared with the base year.

Price of Market basket of goods in CURRENTS / price of market basket of goods in a BASE YEAR TIMES A 100

GDP deflator is a price index used to adjust from nominal GDP to real GDP.
In the base year the GDP deflator is equal to 100.
For years after the base year the GDP deflator is greater than 100.
For years before the base year GDP deflator is less than 100.

GDP deflator formula.

Nominal GDP/ real GDP times 100

Inflation is new GDP deflator minus old GDP deflator

Measuring Inflation

A) Inflation Rate measures the percentage increase of the price level over time. Offers a key contributor in the economy help.

Deflation occurs when the Inflation rate declines.

Difference between deflation and disinflation.

Consumer price index (CPI) measures inflation by tracking the yearly price of a fixed basket of consumer goods and services. CPI indicates changes in the price level and cost of living.

Solving Inflation Problems.
 

A. Formula: for finding inflation rate using market basket data

current year market basket value minus base year market basket value over base year market baskets value times 100

B. Formula: finding inflation rate using price index

Current year price index minus base year price index over price year price index times 100.

C. Formula for estimating inflation rate using price indexes
Years needed to double inflation equals the annual inflation rate.

Is used to calculate the number of years It will take for the price level to double at any rate of inflation.

D. Formula for determining wages
Real wages equals nominal wages divided by the price level times 100.

E. Formula for finding real interest rate.
Nominal interest rates minus inflation premium gives you the real interest rate

Real interest is the cost of borrowing or lending money that is adjusted for inflation.
Nominal interest rate is the unadjusted rate of borrowing or lending money.

Causes of Inflation.
A) Demand pull inflation is caused by a excess of demand over output that pulls prices upward.
B) Cost push inflation is caused by a rise in per unit production cost due to increasing resource cost.

Effects of inflation

Anticipated vs Unanticipated
People helped by inflation:
Borrowers: since debt will be repaid with cheaper dollars than those who are loaned out 
Unanticipated people hurt: fixed income. Scholarship people. Social security people. Savers. Lenders and creditors.