Unit 7

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: exist when a country can produce more of a good/service than another country 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.
• Ex. for input: number of hours to do a job, number of acres to feed a horse, number of gallons of paint to paint a house.
• Ex. for output:

Specialization and Trade

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

Unit 7

Mechanics of Foreign Exchange (FOREX)

• Foreign Exchange (FOREX)
• The buying and selling of currency
• Ex. In order to purchase souvenirs in France, it is first necessary for Americans to sell their Dollars and buy Euros.
• Any transaction that occurs in the balance of Payments necessitates foreign exchange.
• The exchange rate (e) is determined in the foreign currency market.
  
• Changes in Exchange Rates
• Exchange rates (e) are a function of the supply and demand for currency.
• An increase in the supply of a currency will decrease the exchange rate of a currency.
• An decrease in the supply of a currency will increase the exchange rate of a currency.
• An increase in the demand of a currency will increase the exchange rate of a currency.
• An decrease in the demand of a currency will decrease the exchange rate of a currency.
• Appreciation and Depreciation
• Appreciation of a currency occurs when the exchange rate of that currency increase (e↑)
• Depreciation of a currency occurs when the exchange rate of that currency decrease (e↓)
• Exchange Rate Determinants
• Consumer Tastes
• Relative Income
• Relative Price Level
• Speculation
• Exports and Imports
• The exchange rate is a determinants 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 on demand and supply of that currency vs. other currencies.
• It is very sensitive to the business cycle
• Provide options for investment
• Fixed Rates
• Based upon a country's willingness to distribute currency and the ability to control the amounts.

Unit 7

Formulas

• Balance of Trade:
  Goods Exports + Goods Imports
• Balance on goods and services:
  Goods Exports + Service Exports + Goods Imports + Service Imports
• Current Account:
  Balance on goods and services + Net Investment + Net Transfers
• Capital Account:
  Foreign Purchases + Domestic Purchases

Unit 7

Balance of Payment Chart

	Assets (+) Demand for the $ "Inflows"	Debits/Liabilities (-) Supply of the $ "Outflows"
Current Accounts (CA)
Balance on Goods & Services Net Exports (Xn) Balance of Trade	Exports Tourism here	Imports Tourism there
Net Investment	Interest/dividend payments foreigner paid to the U.S. for use of exported capital.	Interest/dividend payments the U.S. made for use of foreign capital invested in the U.S.
Net Transfers	Aid to the U.S. Transfers back to the U.S. Our royalties	Aid to them Remittances from the U.S. Their royalties
Financial Accounts (K) or (KA) -or- "Financial and Capital Accounts" -or-     "Capital Accounts"	Capital inflows Direct investment in the U.S by  foreigners Purchases of stocks and bonds by foreigners.	Capital outflows Direct investment by the U.S. over there Purchases of stocks and bonds by the U.S.
Official Reserves or Official Settlements or Special Drawing Rights	Currencies IMF holdings Gold	Currencies IMF holdings Gold

Unit 7

The Balance of Payment

• Balance of Payment
• Measure of money inflows and outflows between the united States and the Rest of the World (ROW).
• Inflows are referred to as CREDITS.
• Outflows are referred to as DEBITS.
• The Balance Payments is divided into 3 accounts
• Current Account
• Capital/Financial Account
• Official Reserves Account
• Current Account
• Balance of Trade or Net Exports
• Exports of Goods/Services - Imports of Goods/Services
• Exports create a credit to the balance of payments.
• Imports create a debit to the balance of payments.
• Net Foreign Income
• Income earned by U.S. owned foreign assets - Income paid to 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 → a debit to the current account
• Ex. Mexican migrant workers send money to family in Mexico.
• Capital/Financial Account
• The balance of capital ownership
• Includes the purchase of both real and financial assets.
• Direct investment by U.S. firms/individuals in a foreign country are debits to the capital account.
• Purchase of foreign financial assets represents a debit to the capital account.
• Purchase of domestic financial assets by foreigners represents a credit to the capital account.
• Relationship between Current and Capital Account
• The Current Account and Capital Account should zero each other out.
• That is...If the Current Account has a negative balance (deficit), then the Capital Account should then have a positive balance (surplus)
• Official Reserves
• The foreign currency holdings 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.
• When there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments.
• Where there's a balance of payments the Fed depletes
• Active v. Passive Official Reserves
• The United States is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.

Unit 6

Economic Growth & Productivity

• 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.
• It 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 expectations
• 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 and debt increasing long term interest rates
• Increased income inequality → Populist policies
• Restriction on Free International Trade

Unit 5

Supply Side Economics

Changes inAS and not AD are the main active force in determining the level of inflation, unemployment rates, and economic growth.

• Supply side Economist: support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments such as: unemployment compensation or welfare programs provide disincentives to work, invest, innovate, and undertake entrepreneur ventures.
• Incentive to Save & Invest
1. High marginal tax rates reduce the rewards for saving and investment.
2. Consumption might increase but investments depend upon savings.
3. Lower marginal tax rates encourage saving and investment.

Laffer Curve

• A theoretical relationship between tax rates and tax revenues.
• As tax rate increase from zero, tax revenue increase from zero to some maximum level and then decline.
• 3 Criticisms
1. Evidences suggest that the impact of tax rates on incentives to work, save, and invest are small.
2. Tax cuts also increase demand which can fuel inflation, and demand may exceed supply.
3. Where the economy is actually located on the curve is difficult to determine.

Unit 5

Misery Index

• A combination of inflation and unemployment in any given year. Single digit misery is good.
• Supply Shocks: rapid and significant increase in resource cost.
• Disinflation: reduction and inflation fro year to year. Found in the LRPC.
• Deflation: general decline in prices.
• Inflation: general rise in prices.
• Stagflation: unemployment and inflation rise/increase at the same time.

Unit 5

The Phillips Curve

• The Long-Run Phillips Curve: measure of inflation and unemployment. Natural rate of unemployment is held constant.
  
• Because the LRPC exists at the natural rate of unemployment (U_N), structural changes in the economy that affects U_N will also cause the LRPC to shift.
• Increase in U_N will shift LRPC →
• Decrease in U_N will shift LRPC ←
• Relating Phillips Curve to AS/AD
• Changes in the AS/AD model can also be seen in the Phillips Curve.

Long Run

• Occurs at the natural rate of unemployment.
• Always represented by a vertical line.
• There is no trade off between unemployment and inflation.
• If the NRU changes so does the LRPC
• NRU = Frictional + Structural + Seasonal Unemployment
  (4-5%)
• The major LRPC assumption is that more worker benefits create higher natural rates and a few worker benefits create lower natural rates.

Unit 5

Short Run Aggregate Supply

The period in which wages (and other input prices) remain fixed as price level increases or decreases.

• Effects over Short Run
• In the short run, price level changes allow for companies to exceed normal outputs and hire more workers because profits and increasing 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 Long AD Curve is represented with a vertical line.

Demand Pull Inflation in the AS Model

• Demand-Pull: prices increase based on increase in aggregate demand.
• In the short run, demand pull will drive up prices, and increase production.
• In the long run, increases in aggregate demand will eventually return to previous levels.

Cost Push and the Extended Model

• Cost-Push arises from factors that will increase per unit cost such as increase in the price of key resource.

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 employments levels declining.

Unit 4

What Banks Do

• A bank is a financial intermediary
• Uses liquid assets (i. e. bank deposits) to finance the investments of borrowers.
• Process is known as Fractional Reserve Banking
• A system in which depository institutions hold liquid assets less than the amount of deposits.
• Can take the form of:
1. Currency in bank vaults
2. Bank Reserves: deposits held at the Federal Reserve
• Basic Accounting Review
• T-Account (Balance Sheet)
• Statements of assets and liabilities
  
• Assets (Amounts owned)
• Items to which a bank holds legal claim
• The uses of funds by financial intermediates
• Liabilities (Amounts owed)
• The legal claims against a bank
• The sources of funds for financial intermediaries
• Function of the FED
1. Issues paper currency
2. Sets reserve requirements and hold reserves of the bank
3. Lends money to the banks and charges them interest
4. They are a check clearing service for bank
5. They act as a personal bank for the government
6. They supervise number of banks
7. They control the money supply in the economy

Unit 4

• When a customer deposits cash or withdraws cash from their demand deposit account, it has no effect on the money supply.
  It only changes:
1. The composition of money
2. Excess Reserves
3. Required Reserves
• Single Bank
• Loan from your excess reserves
• Banking System
• ER x multiplier
  Total money supply
• FED
• When the FED buys or sells bonds, ER is created.

Unit 4

Counter-cyclical Policies: Keynesian Fiscal Policy vs. Monetary Policy

In the early 21^st Century, here in the USA:

An efficient, "full employment" economy will probably have:

1. An annual unemployment rate of 4-5%.
2. An annual inflation rate of 2-3%.


If the economy goes into recession:
3. The real GDP will decrease for at least 6 months.
4. The unemployment rate will go to 6% or more.
5. The inflation rate will probably go to 2% or less.


If Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the recession, then:
6. The policy will try to improve C, or G (parts of AD).
7. Congress will decrease federal taxes.
8. Congress will increase job and spending programs.
9. The federal budget will probably create a deficit.
10. Due to changes in Money Demand, interest rates will increase.
    (Crowding out might occur, but Keynesians don't care.)


If the Federal Reserve employs Monetary Policy options to slow/stop the recession, then:
11. The policy will target improvement in Ig (part of AD).
12. The Fed will target a lower federal fund rate.
13. The Fed can lower the discount rate.
14. The Fed can buy bonds (Open Market Operations).
15. The Fed can (theoretically) lower the reserve requirement, but probably won't because it is too complex for the banks.
16. These Fed policies will lower the interest rates through changes in the Money Supply.
17. These options should increase Ig.


If the economy suffers from too much demand-pull inflation or cost-push inflation, then:
18. The unemployment rate will go to 4% or less.
19. The inflation rate will probably go to 4% or more.


If Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the inflation problems, then:
20. The policy will try to decrease C, or G (parts of AD)
21. Congress will increase federal taxes.
22. Congress will decrease job and spending programs.
23. The federal budget will probably create a surplus.
24. Due to changes in Money Demand, interest rates will decrease.


If the Federal Reserve employs Monetary Policy options to slow/stop the inflation problems, then:
25. The policy will target decreases in Ig (parts of AD).
26. The Fed will target a higher federal funds rate.
27. The Fed can increase discount rate.
28. The Fed can sell bonds (Open market Operations).
29. The Fed can (theoretically) raise the reserve requirement, but probably won't because it is too complex for the banks.
30. These Fed policies will increase the interest rates through changes in the Money Supply.
31. Thes options should decrease Ig.

Unit 4

1. The Reserve Requirement
• Only a small percent of your bank deposit is in the safe. The rest of your money has been loaned out. This is called "Fraction Reserve Banking."
• The FED sets the amount that banks must hold.
• The reserve requirement (reserve ratio) is the percent of deposits that banks must hold in reserve and NOT loan out.
1. If there is a recession, what should the FED do to the reserve requirement?
• Decrease the Reserve Ratio
1. Banks hold less money and have more excess reserves.
2. Banks create more money by loaning out excess.
3. Money supply increases, interest rate fall, AD goes up
2. If there is inflation, what should the FED do to the reserve requirement?
• Increase the Reserve Ratio
1. Banks hold more money and have less excess reserves.
2. Banks create less money by loaning out.
3. Money supply decreases, interest rate rise, AD goes down.
2. The Discount Rate
• The Discount Rate is the interest rate that the FED charges commercial banks.
• To increase the money supply, the 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
• The FED buys/sells government bonds (securities)
• This is the most important and widely used monetary policy
• To increase the money supply, the FED should buy government securities.
• To decrease the money supply, the FED should sell government securities.

	Easy Money	Tight Money
Monetary Policy	Expansionary	Contractionary
Open Market Operation	Buy bonds	Sell bonds
Discount Rate	Decrease	Increase
Reserve Requirement	Decrease	Increase

Federal Funds Rate: this is where FDIC member banks loan each other overnight funds.

Prime Rate: the interest rate that banks charge their most credit and worthy customer.

Unit 4

Demand for Money

• Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded.
1. What happens to the quantity demand of money when interest rate increase?
   Quantity demanded falls because individuals would prefer to have interest earning assets instead of borrowed liabilities.
2. What happens to the quantity demanded when interest rates decrease?
   Quantity demanded increases there is no incentive to convert cash into interest earning assets.
• Money Demand Shifters
1. Changes in price level
2. Changes in income
3. Changes in taxation that affects investment
• Increasing the Money Supply
• If the FED increases the money supply, a temporary surplus of money will occur a 5% interest.
• The surplus will cause the interest rate to fall to 10%.
• Decreasing the Money Supply
• If the FED decreases the money supply, a temporary shortage of money will occur a 5% interest.
• The shortage will cause the interest rate to rise to 10%.
• How does this affect AD?
  Decrease money supply→Increase interest rate→Decrease investment→Decrease AD

Financial Sector

• Financial Assets vs. Financial Liabilities
• Financial Assets: stocks and bonds whose benefit to the owner depends upon the issuer of the asset meeting certain obligations.
• Financial Liabilities: liabilities incurred by the issuer of a financial asset to stand behind the issued asset.
• Interest Rate: the price paid of a use of a financial asset
• Stocks vs. Bonds
• Stocks: a financial asset that conveys ownership in a corporation
• Bonds: a promise to pay a certain amount of money plus interest in the future.

Unit 4

Time Value of Money

• Is a dollar today worth more than a dollar tomorrow?
  Yes
• Why?
• Opportunity cost & Inflation
• This is the reason for charging and paying interest.
• Let v=future value of money
  p=present value of money
  r=real interest rate (nominal rate - inflation rate) expressed as a decimal
  n=years
  k=number of times interest is credited per year
• The Simple Interest Formula
  v=(1+r)ⁿ×p
• The Compound Interest Formula
  v=(1+r/k)^nk×p
• Assume that inflation is expected to be 3% and that the nominal interest rate on simple interest savings is 1% after 1 year.

Unit 4

Money

1. 3 Uses of Money
1. Medium of Exchange: barter
2. Unit of Account: establishes economic work in the exchange process.
3. Storage Value: money holds its value over a period of time.
2. Types of Money
1. Commodity Money: it gets its value from the type of material from which it is made.
2. Representative Money: paper money backed by something tangible that gives it value.
3. Fiat Money: use in the US, it is money because the government says so.
3. Characteristics of Money
1. Portable
2. Durable
3. Divisible
4. Limited Supply
5. Acceptable
6. Uniform
4. Money Supply
• M1 Money: consist of money in circulation, checkable deposit (checking account) and travelers checks (75%). Held as a medium of exchange. It is the most liquid.
• M2 Money: consist of M1 money along with savings accounts, money market accounts, and deposits held by banks outside of the US.
• M3 Money: encompasses M2 money and certificate deposits (CD).

Unit 3

Fiscal Policy

Changes in expenditures or tax revenues of the federal government.

• 2 Tools of fiscal policy:
• Taxes: government can increase or decrease taxes.
• Spending: government can increase or decrease spending.
• 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 aa budget deficit.
• Government borrows from
• Individuals
• Corporations
• Financial Institution
• 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)
• Discretionary v. 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.
• Automatic: Unemployment compensation & 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.

• Expansionary Fiscal Policy	Contractionary Fiscal Policy
  Combat a recession Increase in Government Spending Decrease in Taxes	Combat inflation 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 policymakers.
• Social security
• Unemployment
• Medicaid/Medicare
• Veterans compensation

Progressive Tax System

• Average tax rate (tax revenue/GDP)

Proportional Tax System

• Average tax rate remains constant as GDP changes

Regressive Tax System

• Average tax rate falls with GDP.

Unit 3

The Spending Multiplier Effect

• An initial change in spending (C, Ig, G, Xn) causes a larger change in aggregare spending, or Aggregate Demand (AD)
• Multiplier = ΔAD/ΔC, I, G, or X

Calculating the Spending Multiplier

• The Spending Multiplier can be calculated from the MPC or the MPS.
• Multiplier = 1/1-MPC or 1/MPS
• Multiplier are (+) when there is an increase in spending and (-) when there is a decrease.

Calculating the Tax Multiplier

• When the government taxes, the multiplier works in reverse
• Why?
• Because now money is leading the circular flow
• Tax Multiplier (note: it's negative)
• = -MPC/1 - MPC or -MPC/MPS
• If there is a tax-CUT, then the multiplier is +, because there is now more money in the circular flow.

Consumption and Savings

• Disposable Income (DI)
• Income after taxes or net income
• DI = Gross Income - Taxes
• 2 Choices
• With disposable income, households can either
• Consume (spend money on goods and services)
• Save (not spend money on goods and services)
• 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
• 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
• APC & APS
• APC + APS = 1
• 1 - APC = APS
• 1 - APS = APC
• APC > 1 = Dissaving
• -APS = Dissaving
• Marginal Propensity to Consume (MPC)
• The fraction of any change in disposable income that is consumed.
• MPC = ΔC/ΔDI
• Marginal Propensity to Save (MPS)
• The fraction of any change in disposable income that is saved.
• MPS = Δsavings/ΔDI
• Marginal Propensities
• MPC + MPS = 1
• MPC = 1 - MPS
• MPS = 1 - MPC

Unit 3

Classical vs. Keynesian

Topic	Classical	Keynesian
Modern followers	Neoclassical Supply siders Adam Smith J. B. Say David Richards Alfred Marshal	Neokeynesians J. M. Canes
Say's Law	Supplies creates its own demand. Production = income = spending Under-spending is unlikely	Depressions refute Say's law Demand creates its own supply Underspending persist
Savings and Investment	Savings = Investment income	Savings ≠ Investment Different motivations
Loanable Funds Market	Table Cell	Investment from savings, cash, checking, accounts Leanding creates money which causes supply of money increase. Inflation and unemployment is unstable.
Wage/price flexibility	If AD decrease, price level decrease and assumes competition	Inflexible downward Flexible upward only
Supply Curve	Vertical	Horizontal
Output and Employment	AS determines output and employment	AD determines output and employment
Unemployment	Rarely exist due to wage/price flexibility Causes: external-war	Usually exist Causes: external-war               internal-savings ≠ investment
Aggregate Demand (AD)	AD determines the price level AD is reasonably stable if money supply is stable	AD changes due to the determinants AD is unstable even if money supply is stable due to fluctuations
Basic Equation	MV = P x Q	C + Ig + G + Xn = GDP
Role of Government	Monetary rule maintain a money supply Laissez Faire is best Economy is self regulating	Fiscal policy means Active government Economy is not self regulating
Inflation	Caused by too much money	Caused by too much demand
How long the short run is	Very short time	Long time
Emphasis Today	Microeconomics	Macroeconomics

Unit 3

Investment

• Money spent or expenditures on:
• New plants (factories)
• Capital equipment (machinery)
• Technology (hardware & software)
• New homes
• Inventories (goods sold by producers)
• Expected Rates of Return
• How does business make investment decisions?
• Cost/Benefit Analysis
• How does business determine the benefits?
• Expected rate of return
• How does business count the cost?
• Interest costs
• How does business determine the amount of investment they undertake?
• 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.
• How do you compute the real interest rate (r%)?
• r% = i% - π%
• What then, determines the cost of investment cost?
• The real interest rate (r%)
• Investment Demand Curve (ID)
• What is the shape of the investment demand curve?
• Downward sloping
• Why?
• When interest rates are high, fewer investments are profitable, when interest rates are low, more investments are profitable.
• Shifts in Investment Demand (ID)
• Cost of Production
• Lower costs shift ID →
• Higher costs shift ID ←
• Business Taxes
• Lower business taxes shift ID →
• Higher business taxes shift ID ←
• Technological Change
• New technology shifts ID →
• Lack of technological change shifts ID ←
• Stock Capital
• If an economy is low on capital, then ID →
• If an economy has much capital, then ID ←
• Expectations
• Positive expectations shift ID →
• Negative expectations shift ID ←

Unit 3

Full Employment

• Full Employment equilibrium exists where AD intersects SRAS & LRAS at the same point.
  
• A recessionary gap exists when equilibrium occurs below full employment output.
  
• An inflationary gap exists when equilibrium occurs beyond full employment output.
  

Nominal Wages vs. Real Wages

• Nominal wages: the amount of money received by a worker per unit of time.
• Real wages: the amount of goods and services a worker can purchase with their nominal wage.
• Sticky wages: nominal wage level that is set according to an initial price level and it does not vary due to labor contracts or other restrictions.

Unit 3

Aggregate Study

• The level of Real GDP (GDP_R) that firms will produce at each Price-Level (PL)

Long-Run v. Short-Run

• Long-Run
• Period of time where input prices are completely flexible and adjust to changes in the price-level.
• In the long-run, the level of Real GDP supplied is independent of the price level.
• Short-Run
• Period of time where input prices are sticky and do not adjust to changes in the price-level.
• In the short-run, the level of Real GDP supplied is directly related to the price-level.

Long-Run Aggregate Supply (LRAS)

• The Long-Run Aggregate Study 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 profits and therefore do not change firms' level of output. This means that the LRAS is vertical at the economy's level of full employment.

Changes in SRAS

• An increase in SRAS is seen as a shift to the right. SRAS →
• A decrease in STAS is seen as a shift to the left. SRAS ←
• The key to understanding shifts in SRAS is per unit cost of production.
• Per unit production cost = total input cost/total output cost

Determinants of SRAS

• Input Prices
• Domestic Resource Prices
• Wages (75% of all business costs)
• Cost Capital
• Raw materials (commodity prices)
• Foreign Resource Prices
• Market Power
• Increases in Resource Prices = SRAS ←
• Decreases in Resource Prices = SRAS →
• Productivity
• Productivity = total output/total inputs
• More productivity = lower unit production cost = SRAS →
• Lower productivity = higher unit production cost = SRAS ←
• Legal-institution environment
• Taxes and Subsidies
• Taxes ($ to government) to business reduce per unit production cost = SRAS ←
• Subsidies ($ from government) to business reduce per unit production cost = SRAS →
• Government Regulation
• Government regulation creates a cost of compliance = SRAS ←
• Deregulation reduces compliance costs = SRAS →

Unit 3

Shifters of Aggregate Demand

• There are two parts to a shift in AD:
• A change in C, Ig, G and/or Xn
• A multiplier effect than produces a greater change than the original change is the 4 components.
• Increases in AD = AD →
• Decreases in AD = AD ←
  

Determinants in AD

• Consumption
• Household spending is affected by:
• Consumer wealth
• More wealth = more spending (AD shifts →)
• Less wealth = less spending (AD shifts ←)
• Consumer expectations
• Positive expectation = more spending (AD shifts →)
• Negative expectation = less spending (AD shifts ←)
• Household indebtedness
• Less debt = more spending (AD shifts →)
• more debt = less spending (AD shifts ←)
• Taxes
• Less taxes = more spending (AD shifts →)
• More taxes = less spending (AD shifts ←)
• Gross Private Investment
• Investment Spending is sensitive to:
• The Real Interest Rate
• Lower Real Interest Rate = More Investment (AD →)
• Higher Real Interest Rate = Less Investment (AD ←)
• Expected Returns
• Higher Expected Returns = More Investment (AD →)
• Lower Expected Returns = Less Investment (AD ←)
• Expected Returns are influenced by
• Expectations of future profitability
• Technology
• Degree of Excess Capability (Existing Stock of Capital)
• Business taxes
• Government Spendings
• More Government Spending (AD →)
• Less Government Spending (AD ←)
• Net Exports
• Net Exports are sensitive to:
• Exchange Rates (International value of money)
• Strong $ = More Imports and Fewer Exports = (AD ←)
• Weak $ = Less Imports and More Exports = (AD →)
• Relative Income
• Strong Foreign Economies = More Exports = (AD →)
• Weak Foreign Economies = Less Exports = (AD ←)

Unit 3

Aggregate Demand Curve

• AD is the demand by consumers, businesses, government, and foreign countries.
  What definitely doesn't shift the curve?
  Changes in price level cause a move along the curve.
• Why is AD downward sloping?
1. Real-Balance Effect
• Higher price levels reduce the purchasing power or money.
• This decreases the quantity of expenditures.
• Lower price levels increase purchasing power and increases expenditures.
• Ex: If the balance in your bank was $50,000, but inflation erodes your purchasing power, you will likely reduce your spending.
  So... Price level goes up, GDP demand goes down.
2. Interest-Rate Effect
• When the price level increases, lenders need to charge higher interest rates to get a REAL return on their loans.
• Higher interest rates discourage consumer spending and business investment. WHY?
• Ex: An increase in prices leads to an increase in the interest rate from 5% to 25%. You are less likely to take out loans to improve your business.
3. Foreign Trade Effect
• When U.S. price level rises, foreign buyers purchase fever U.S. goods and Americans buy more foreign goods.
• Exports fall and imports rise causing real GDP demanded to fall. (Xn Decreases)
• Ex: If prices triple in the US, Canada will no longer buy US goods causing quantity demanded of US products to fall. Again, Price Level goes up, GDP demanded goes down (and Vice Versa)

Unit 2

Circular Flow Diagram

It represents the transaction in the economy.

• Resource (Product) Market: this is the place where households sell resources and businesses buy resources. (Goods & services)
• Factor Market: holds your factors of production.
• Firm: an organization that provides goods and services for sale. Firms sell finished products to households.
• Household: a person or group of people that share their income. Household sell their factors of production to businesses.

Gross Domestic Product (GDP)

The market value of all final goods and services produced within a country's borders within a given year.

• Gross national Product (GNP): the total value of all final goods and services by citizens of that country on its land or foreign land.
• What's included in GDP
• C - Personal consumption expenditures
• Ig - Gross Private Domestic Investment
1. Factory equipment
2. Factory equipment maintenance
3. Construction of housing
4. Unsold inventory of products built in a year
• G - Government spending
• Xn - Net exports (exports-imports)
• What's not included in GDP
1. Intermediate goods: goods that required further processing before they're ready for final use.
2. Used/Secondhand goods
• Avoid double counting
3. Purely financial transaction (stocks and bonds)
4. Illegal activities (drugs)
5. Unreported business activity (unreported tips)
6. Transfer Payments
• Public (social security, welfare)
• Private (scholarship)
7. Non-market activity
• Volunteer work
• Babysitting
• Any work you performed yourself

2 Ways of Calculating GDP

• Expenditure approach: add up all of the spending on final goods and services produced in a year.
  GDP = C + Ig + G + Xn
• Income approach: add up all of the income that resulted from selling all final goods and services produced in a given year. Rarely used because people lie about their income.
  GDP = W + R + I + P + Statistical adjustment
• Compensation of Employees: include wages, salaries, social security contribution, and health and pension plans.
• Rents: income of property owners.
• Interest: income that comes from money.
• Corporate profits: the income of the company stockholders.
• Proprieter's income: the income of sole proprietorship and incomeship.
• Statistical adjustment
1. Indirect business taxes
2. Depreciation
3. Net foreign factor payment

Formulas

• Budget: government purchases of goods and services + government transfer payments - government tax and fee collection
  Positive # = Budget Deficit                  Negative # = Budget Surplus
• Trade: exports - imports
  Positive # = Trade Surplus                  Negative # = Trade Deficit
• National income: 
• compensation of employees + rental income + interest income + corporate profits + proprietor's income
• GDP - indirect business taxes - depreciation - net foreign factor payment
• Disposable Personal Income: national income - personal household taxes + government transfer payments
• GNP = GDP + Net foreign factor payment
• Net Domestic Product (NDP): GDP - depreciation
• Net National Product (NNP): GNP - depreciation
• Real GDP: the value of output produced in constant base year prices. Increase only if quantity increases. Used to measure economic growth. Price X Quantity
• Nominal GDP: the value of output produced in current prices. It can increase from year to year if price and quantity increase. Used to measure price increases (inflation). Price X Quantity
• GDP Deflator: a price index used to adjust from nominal to real GDP.
  (Nominal GDP / Real GDP) X 100
• Consumer Price Index (CPI): the most commonly used measurement of inflation for consumers.
  (Current year / Base year) X 100
• Calculation for inflation: (GDP Deflator of current year - GDP Deflator of base year) / Base year X 100
• In the base year GDP Deflator is 100.
• For years after the base year, GDP Deflator is greater than 100.
• For years before the base year, GDP Deflator is less than 100.

Real Interest Rate vs. Nominal Interest Rate

• Real interest rate was adjusted for inflation
• Nominal interest rate was not adjusted for inflation
• Real Interest Rate = Nominal Interest Rate - Inflation

Inflation

It taxes those who receive relatively fixed income.

Unanticipated Inflation

• Hurt by Inflation
1. Lenders
2. People with a fixed income (elderly, welfare)
3. Savers
• Helped by Inflation
1. Debtors
2. A business where the price of the product increases faster than the price of resources.
• COLA: Cost of Living Adjustment

Unemployment

The failure to use available resources particularly labor to produce desired goods and services.

• Unemployment Rate: 4% to 5% = Full employment or Natural Rate of Unemployment (NRU)
• Labor Force:
• Above 16 years of age
• Able and willing to work
• Not in the Labor Force:
• Military
• Jail/Prison
• Mental Institutions
• Retired people
• Students
• Homemaker
• People who are not looking for a job
• How to calculate the unemployment rate: # of unemployed / (# of employed + # of unemployed) X 100
• Type of Unemployment:
• Frictional: temporarily unemployed or in between jobs.
1. High school or college graduate looking for an opportunity
2. Better position
• Structural: workers do not have transferable skills and these jobs never come back.
• Seasonal: type of unemployment due to the time of the year and nature of job.
• Cyclical: results from economic downturns. As demands for goods and services fall, demand for labor and worker also fall.

GDP Gap

The amount by which actual GDP falls short of potential GDP.

• Okun's Law: states for every 1% that actual unemployment rate exceeds the natural rate of unemployment. A GDP gap of about 2% occurs.
• Rule of 70: it is used to determine how many years it takes for a value to double given a particular annual growth rate.
  70 / (Interest rate)

Unit 1

Macroeconomics vs. Microeconomics

• Macroeconomics: the study of the economy as a whole.
• minimum wage
• international trade
• supply and demand
• Microeconomics: the study of individual or specific unit of economy.
• market structures

Positive Economic vs. Normative Economics

• Positive economic: claims that attempt to describe the world as is.
• Collects & presents facts
• Normative economic: claims that attempt to prescribe how the world should be.
• "Ought to be" and "should be" opinion

Needs vs. Wants

• Needs: basic requirement for survival (food, water, shelter, clothes)
• Wants: desire of citizens

Goods vs. Services

• Goods: tangible commodities
• Capital good: items used in creation of other goods such as factory machines and trucks.
• Consumer good: goods that are used for consumers.
• Service: work that is performed for someone.

Scarcity vs. Shortage

• Scarcity: the most fundamental economic problem that all societies face. Were trying to satisfy unlimited wants with unlimited resources.
• Shortage: quantity demanded is greater than quantity supply.

Factors of Production

Resources required to produce goods and services.

1. Land-natural resources
2. Labor-work force
3. Capital
• Physical capital (tools, machinery, robots, factories)
• Human capital (skills, talents, and knowledge)
4. Entrepreneurship
• innovative
• risk taker

Trade-offs: alternatives that we give up whenever we chose one course of action over another.

Opportunity cost: form of trade-off. Next best alternative.

Production Possibility Curve (PPC)

It showed alternative ways in how to use a country's resources.

Four Assumptions of PPG

1. Two goods: resources are used to produce one or both of only two goods.
2. Fixed resources: the quantities of land, labor, capital, and entrepreneurship resources do not change.
3. Fixed technology: the information and knowledge that society has about the goods and services is fixed..
4. Technical efficiency:
   

Efficiency

Using resources in such a way in maximize the production of goods and services

• Allocative efficiency: the products being produced are the ones being desired by society.
• Productive efficiency: products are being produced in the least costly way.
• Under-utilization: using fewer resources than the economy is capable of using.

What Causes the PPC to Shift?

1. Technological change
2. Change in resources
3. Economic growth
4. Change in the labor force
5. Natural disasters/war/famine
6. More education (human capital)

Elasticity of Demand

A measure of how consumers react to a Δ in price.

• Elastic Demand: demand that is very sensitive to a Δ in price. The product is not a necessity and there are available substitutes. E > 1
• Inelastic Demand: demand that is not very sensitive to a Δ in price. The product is a necessity, there are a few substitutes and people will buy no matter what. E < 1
• Unit/Unitary Demand: E = 1

Cost of Production

• Total Revenue: the total amount of money a firm receives from selling goods and services. P x Q = TR
• Fixed Cost: a cost that does not change no matter how much of a good is produced.
• Variable Cost: a cost that rises or falls depending on how much is produced.
• Marginal Cost: the cost of producing one more unite of a good. TCnew - TCold
• Formula:
• TFC+TVC=TC
• AFC+AVC=ATC
• TFC/Q=AFC
• TVC/Q=AVC
• TC/Q=ATC
• TFC=AFC x Q
• TVC=AVC x Q

Price Elasticity of Demand (PED)

Step 1: Quantity          (New quantity - Old quantity)/Old quantity

Step 2: Price                (New price - Old price)/Old price

Step 3: PED                 (% Δ in quantity demanded)/% Δ in price

Supply and Demand

• Supply: the quantities that producers or sellers are willing and able to produce at various prices.
• Law of Supply: there is a direct relationship between price and quantity supply.
• Change in Supply:
1. Δ in expectation
2. Δ in weather
3. Δ in # of suppliers
4. Δ in cost of production
5. Δ in taxes or subsidies
6. Δ in technology
• Demand: the quantities that people are willing and able to buy at various quantities.
• Law of Demand: states there is an inverse relationship between price and quantity demanded.
• Change in Demand:
1. Δ in buyer's taste (advertisement)
2. Δ in # of buyers (population)
3. Δ in price of related goods
• complementary goods
• substitute goods
4. Δ in income
• normal good: an increase in income that causes an increase in demand.
• inferior good: an increase in income causes a fall in demand.
5. Δ in expectation (future)
• Equilibrium: the point at which the supply curve and the demand curve intersect. All resources are being efficiently used.
• Excess demand: occurs when the quantity demanded is greater than the quantity supplied.
• Price ceiling: occurs when the government puts a legal limit on how high the price of a product can be.
• Excess supply: occurs when the quantity supplied is greater than the quantity demanded.
• Price floor: the lowest legal price a commodity can be sold at.