Everyone Loves Econ Notes

Transcription

1 Unit 1: Economic Fundamentals Everyone Loves Econ Notes Scarcity - the lack of resources for our unlimited wants. Ceteris Paribus Economists hold factors constant, except for what s being considered Goods and services produced from land, labor, capital, and entrepreneurship Resources (Factors of Payment) o Land (natural resources) payment = rent o Labor (human resources) payment = wages o Capital (tools, machines, factories) payment= interest o Entrepreneurship (combine land, labor, and capital to make product) payment=profit Opportunity Cost the next best alternative use for certain resources People make decisions on the Margin o Meaning they weigh the costs vs the benefits Production Possibilities Curve (PPC) shows all possible outcomes of full allocation of resources Absolute Advantage The ability to produce the most in a certain amount of time Comparative Advantage ability to produce at a lower opportunity cost Specialization Producing according to Comparative Advantage Law of Supply - sellers will provide more at a higher price than because of: o Law of marginal cost it s more costly to produce two than one, so producers must raise price if producing more Changes in Supply: o Natural Phenomenon Natural disasters, war, riots, and strikes all shift supply o Input Costs Higher input prices (raw materials, technology, labor) decrease supply and vice-versa o Competition An increase in competition (more suppliers) increases supply o Expected Prices If producers expect prices to rise, they will supply less now to sell for higher price later and vice-versa o Joint Supply Prices of by-products move together (ex. Beef and leather prices move together) o Alternate Goods Suppliers will produce more of Good A if it is cheaper to make than Good B o Government Action Business taxes, regulations, and subsidies all change supply Law of Demand a buyer will want more of an item at lower price than a higher price. 3 reasons: o Income Effect when items are expensive money buys less and vice-versa o Substitution Effect people will buy the cheaper of 2 items if they are comparable (ex. Apples and Pears) o Diminishing Marginal Utility each additional item purchased gives less overall happiness Changes in Demand: o Tastes and Preferences people buy what they like (affected by advertising, trends, health considerations, etc.) o Related Goods: Compliments goods and services that go together (ex. Hummer Sales and Gas Prices) Substitutes goods and services used in place of others (ex. Hulu vs TV) o Consumer Income When consumer s income increases, demand for normal goods rises and demand for inferior goods lowers and vice-versa o Population more people=increase in demand

2 o Expectations of Price If prices are expected to rise in future, demand increases now Shifts in supply and demand lead to a change in the equilibrium points Equilibrium -- when supply is equal to demand Equilibrium creates a single price and quantity for a good/service o As demand increases, price and quantity go up and vice-versa o As supply increases price goes down and quantity goes up and vice-versa o If both increase price is unknown and the quantity increases o If both decrease quantity decreases and price is unknown If supply doesn t equal demand then disequilibrium exists o If the price is higher than equilibrium price then there is a surplus o If the price is lower than equilibrium price then there is a shortage o Disequilibrium caused by: Price Floor minimum price for a good outside the market Price Ceiling maximum price for a good outside the market When other forces than supply and demand are used, surpluses and shortages happen Unit 2: Macro Concepts, Circular Flow, Business Cycle Gross Domestic Product (GDP) market value of all final goods and services produced by nation in one year Counted in GDP o Counts: all final, domestic production in a market transaction o Doesn t Count: Used and intermediate goods o Doesn t Count: Non-market and Black Market production GDP= Consumption (C) + Gross Private Investment (Ig) +Govt. Spending (G) + Next Exports (Xn) o C: Spending on goods and services (largest component of GDP) o Ig: Spending now to increase future output or productivity o G: All govt. spending on final goods, services and infrastructure Transfer payments do not count towards GDP o Xn: Exports-Imports Aggregate Spending = GDP = C + Ig +G + Xn Aggregate Income = rent + wages + interest + profits = Factor Payments (see page 1) Nominal GDP current GDP measured at current market prices Real GDP (GDPR) current GDP measured with a fixed dollar o Real GDPYear1 = (Nominal GDP * 100)/Price Index Consumer Price Index measure of overall cost of goods and services bought by typical consumer o Calculate by using a basket of most common products o CPI = (Price of Current Basket/Price of Basket in Base Year) * 100 o Inflation Rate in Year2 = (CPIYear2 - CPIYear1)/CPIYear1 * 100 Inflation (π) when economy s overall price level is rising Inflation Rate (π%) percentage change in price level from one time period to another Problems with CPI (problems measuring Cost of Living) o Substitution Bias Consumers may substitute to cheaper goods than calculated o Introduction of New Goods New products results in greater variety, so value of dollar rises o Unmeasured Quality Changes If quality of good rises from one year to the next then value of dollar rises and vice-versa

3 Problems with CPI Importance: many government programs use CPI to calculate benefits GDP Deflator = (Nominal GDP/Real GDP) * 100 GDP Deflator vs Consumer Price Index o GDP Deflator prices of all goods and services produced domestically o CPI prices of all goods and services bought by consumer Indexation when dollar amount is corrected for inflation Real Interest Rate (r%) = Nominal Interest Rate (i%) Inflation Rate (π%) The circular flow chart shows how money moves within the economy Business Cycle- The rises and depressions of GDP levels Labor Force -- # of people in country classified as either employed or unemployed Labor Force Participation Rate -- % of working age population in labor force (about 65% in the US) Employed 16 years or older that have a job (full time or part time) Unemployed 16 years or older that do not have a job o But have actively searched for one in the last 2 weeks Unemployment Rate = (Number Employed/Number in Labor Force) People not in Labor Force Kids, Military, Retirees, Stay-at-home-moms, full-time students, most of homeless, etc. Four types of Unemployment: o Frictional between jobs, voluntarily jobless Can be good for society and individuals o Structural associated with lack of skills or declining industry (ex. a high school dropout, a type-writer repairman) o Cyclical associated with downturns in business cycle (ex. Layoffs) Bad for society and individuals o Seasonal People who only work during certain seasons (ex. Mall Santas, Lifeguards) Full Employment occurs when no cyclical unemployment is in the economy o Natural Rate of Unemployment is associated with Full Employment (usually around 4%-5%) Price Change = ((CPIFinal CPIInitial)/CPIInitial)*100 Output Growth = ((Real GDPYear 2 - Real GDPYear 1)/ Real GDPYear 1)*100 Index Number (percent change of cost) = (Current year cost/base year cost)*100

4 Unit 3: Aggregate Supply/Aggregate Demand Aggregate Demand shows a negative relationship between price level (PL) and real GDP (GDPR). 3 reasons why: o Real Balance Effect when price level is high households can t afford to purchase as much and vice-versa o Interest Rate Effect High interest rates discourage investment and vice-versa o Foreign Purchase Effect Higher domestic prices increases demand for relatively cheaper foreign goods and vice-versa Determinants of AD are: o Consumption (C) affected by Consumer Wealth, Consumer Expectations, Household Indebtedness, and Taxes o Gross Private Investment (Ig) Affected by Real Interest Rate and Expected Returns o Government Spending (G) more government spending increases AD and vice-versa o Net Exports (XN) Affected by exchange rates (strong dollar means more imports and fewer exports so AD will shift left and vice-versa), and relative income (stronger foreign economies leads to more exports which shifts AD right and vice-versa) Types of Disposable Income: o Net Income the set amount earned each paycheck (after taxes and fees) o Gross Income The total income before taxes Marginal Propensity to Consume (MPC) the percentage of disposable income that is spent o MPC = Change in Consumption ( C)/Change in Disposable Income ( DI) Marginal Propensity to Save (MPS) the percentage of disposable income that is saved o MPS = Change in Savings ( S)/Change in Disposable Income ( DI) MPC + MPS = 1 ALWAYS. Therefore: o MPC = 1 MPS o MPS = 1 MPC Spending Multiplier Effect A change in spending causes a larger change in AS or AD o Multiplier = Change in AD /Change in Spending (Consumption, Investment, Government Spending, Net Exports) Multiplier = AD/ S o Multiplier = 1/(1 MPC) or Multiplier = 1/MPS Tax Multiplier Reverse of spending multiplier because money is leaving circular flow o Tax multiplier = -MPC/1 MPC = -MPC/MPS Aggregate Supply Level of real GDP that firms will produce at each price level (positive relationship between PL and GDPR) Two Types of Aggregate Supply: o Long Run (LRAS): Real GDP supplied is independent of the PL Marks the level of full employment (Yf) in the economy o Short Run (SRAS): Real GDP supplied is directly related to the PL As PL rises, firm s profits rise and they increase supply and vice-versa Determinants of SRAS: o Input prices higher input prices decreases supply and vice-versa (domestic resources more expensive, foreign resource prices more expensive, market prices go up all lead to higher input prices) o Productivity = Total output/total input Higher productivity shifts SRAS right and vice-versa o Legal Institutional Environment More regulation decreases SRAS (Taxes increase, government regulation increases, subsidies decrease all lead to decreased SRAS)

5 LRAS is an indication of full employment Recessionary Gaps when equilibrium is below LRAS Inflationary Gaps when equilibrium is above LRAS Increase in C, Ig, G, or XN leads to increased inflation and a lower unemployment rate and shifts AD right and vice-versa Increase in Input Prices, decrease in productivity, and more regulation in the legal institutional environment increases unemployment and increases inflation and shifts AS left and vice-versa Unit 4: Money and Banking Money anything that can be used as a Medium of Exchange, Store of Index, and a Unit of Account/Standard of Value Money works best when it is: Portable, Durable, Divisible, Acceptable, and Stable US Currency is not backed by gold, only faith Money Supply Federal Reserve (Fed) is the sole issuer of currency. 2 important measures of Money Supply o M1: serves primarily as a medium of exchange (immediate funding) Currency & Coin, Demand Deposits, Checks and Debit Cards o M2: serves as a store of value (money waiting for return later) M1, Time Deposits, Money Market Mutual Funds M1 & M2 o From M2 to M1, money becomes more liquid and vice-versa Time Value of Money o V=future value of $, P=present value of $, R=real interest rate, N=# of years, K=# of times interest is credited per year o Simple Interest Formula v=(1+r) n *p o Compound Interest Formula V=(1+r) nk *p Monetary Equation of Exchange o M= money supply (M1 of M2), V=money s velocity, P=price level, Q= GDPR o MV=PQ o PQ=Nominal GDP Financial Reserve Banking when only a fraction of total money supply is held in reserve as currency o Banks create money by lending more than original reserves had on hand o Lending policies must be prudent to prevent bank panics or runs Bank Regulates through: o Deposit Insurance guarantee by FDIC that depositors will be paid (up to $250,000 per account) o Capital Requirements certain amount of money kept on hand at a bank o Reserve Requirement fraction of total reserves kept at a bank (AKA Reserve Ratio (rr)), usually 10% in US o Discount Window ability of bank to borrow from the Fed, therefore preventing bank failings Money Multiplier (M)= 1/Reserve Ratio (R) Maximum Deposit Expansion = Excess Reserves * Money Multiplier Unit 5: Fiscal and Monetary Policy and Phillips Curve Monetary Policy action the Fed takes to help the economy reach equilibrium. 3 main tools: o Open Market Operations (OMO) Buying and selling of government bonds (most important of the 3 tools) Buying Securities = increases money supply and bank reserves and vice verse o Reserve Ratio Fraction of reserves required to be held If reserve ratio increase, money supply decreases and vice-versa

6 o Discount Rate Interest rate Fed charges to banks to borrow their money If discount rate increases, money supply will decrease and vice-versa Types of Monetary Policy o Expansionary Monetary Policy ( Easy Monetary Policy) when Fed tries to increase the money supply and stimulate economy by: Buying securities Reducing reserve ratio (rarely practiced) Reducing Discount Rate (has little direct impact on money supply) o Contractionary Monetary Policy ( Tight Monetary Policy) when Fed tries to decrease money supply and slow economy by: Selling Securities Increasing Reserve Ratio (rarely practiced) Increasing Discount Rate (has little direct impact on money supply) In the short run, equilibrium can occur at less than, greater than, or equal to full employment. In the long run it can only be at full employment. Fiscal policy government increasing or decreasing Aggregate Demand through changing expenditures and taxes. Contractionary fiscal policy Decreasing AD through increasing taxes and decreasing government spending. Expansionary fiscal policy Increasing AD through decreasing taxes and increasing government spending. Discretionary fiscal policy government must take deliberate action Automatic or Built-in stabilizers change spending or taxes without deliberate action being taken. Fiscal policy that changes spending affects the budget in two ways: o When the government spends more than it taxes in a year, it creates a budget deficit. o When the government spends less than it taxes in a year, it creates a budget surplus. Deficit $ amount spend above budget each year Debt total accumulated deficit Crowding Out when private investments have been crowded out of market by government borrowing Crowding In Government surpluses have encouraged businessmen to borrow more and therefore stimulate the economy Problems with Fiscal Policy o Crowding out and Crowding in o Lag time (government operates slowly) o Political Business Cycle (politicians work had hard at election time and not as much while in office) o Getting Fiscal Policy to work in the open (global) economy Fiscal Policy vs Monetary Policy o Fiscal Policy = Government Action Taxes and Government Spending o Monetary Policy = Action taken by Federal Reserve OMOs, Reserve Requirements, Discount Window o Both monetary and fiscal policies primarily change AD, most other policies change AS. Phillips curve Illustrates relationship between Unemployment Rate (u%) and Inflation Rate (π%) o Short Run Phillips Curve (SRPC) negative relationship between u% and π% o Long Run Phillips Curve (LRPC) no relationship between u% and π% o Shifts in SRAS move SRPC in opposite direction (if SRAS moves right SRPC moves left and vice-versa) o Shifts in AD move opposite along SRPC line (if AD moves right, move left/up along SRPC)