Money. What is Money? 3 Uses of Money #1 Medium of Exchange #2 Unit of Account. #3 Store of Value. 6 Characteristics of. Money.

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1 What is Money? Suppose a generous relative gave you a gift of $1000 for your high school graduation. In a short paragraph outline what you would do with the money and the reason behind your decision. Can money buy happiness? 3 Uses of Money #1 Medium of Exchange #2 Unit of Account #3 Store of Value 6 Characteristics of Money Money used to determine the value of something (commodity); without it, would have to barter allows you to compare the value of goods and services (comparison shopping) retains its value if you spend it or decide to keep it and save it (except in inflation) 1.Durability- must withstand day to day use 2.Portability- must be easy to carry and easily exchanged 3.Divisibility- easily divided into smaller amounts 4.Uniformity- all units are the same no matter how they re found 5.Limited Supply- too much money in the system makes it worthless 6.Acceptability- must be able to exchange it for goods and services Commodity Money Representative Money Fiat Money consists of objects that have value in themselves and that are also used as money. Items of barter in most cases objects that have value because the holder can exchange them for something else of value. Ex. form or paper receipts for gold and silver. Money that has value because the government has ordered that it is an acceptable means to pay debts. Trusted because of the United States economic production and potential backs it. It is also called legal tender

2 Use what you know: Identify each item as M1, M2, or M3 on the line next to the number. 1.Mutual Fund (savings of many individuals invested in a variety of stocks, bonds, and other financial assets) 2. Travelers Checks 3. CD (certificate of deposit) 4. Cold Hard Cash 5. Coins 6. Regular Checking Account 7. Savings Account 8. Money deposited into a bank by a Mexican National. M1 M2 M3 Measure Money Currency in the hands of the public, in checking accounts, and in the form of travelers checks. M1 consists of assets that have liquidity, or the ability to be used as, or directly converted into cash. They are cash like. Often referred to as near money, M2 consists of everything in M1 as well as in savings accounts, small denomination time deposits such as CD s, and money market mutual funds. M2 is not as liquid. Also called near money, can be converted to cash easily. M1 + M2 + foreign deposits

3 Federal Reserve Duties of a Central Bank Structure of the FED Function of the FED Serving the Federal Government Money Creation 1. Holding Reserves 2. Assuring Stability 3. Lending Money 1. 7 members of the Board of Governors 2. Twelve District Banks 3. Member Banks 4. Federal Open Market Committee (FOMC) supervises the sales and purchases of government securities. Service #1 Clear Checking Service #2 Lending Money Service #3 Regulating and Supervising Banks Service #1 Paying Government Bills -Social Security, Medicare, IRS tax refunds Service #2 Selling Government Securities (bonds) Service #3 Distributing Currency FED created money whenever banks receive deposits and make loans. Factors Affecting Demand for Money Factor #1 Cash on Hand Factor #2 Interest Rates Factor #3 Cost of Consumer Goods and Services Factor #4 Level of Income

4 Reserve Requirements An increase in reserve requireme nts cause banks to increase reserves. A reduction in reserve requireme nts causes banks to decrease reserves. Reserve Requirements Banks reduce lending, causing the money supply to contract. Money Supply Banks increase lending, causing the money supply to expand. Monetary Policy Required Reserved Ratio Increase Reserve Requirements Discount Rate Open Market Operations Federal Reserve Monetary Policy Includes the Fed s actions that change the money supply in order to influence the economy. The portion of your $1,000 that the bank needs to keep on hand, or not loan out. Even a slight increase in the RRR would require banks to hold more money in the reserve, shrinking the money supply. Could cause too much disruption in the banking system The interest rate that banks pay to borrow money from the FED Most important monetary tool The buying and selling of government securities to alter the monetary supply Bond A formal contract to repay borrowed money with interest at fixed intervals.

5 Income Tax Questions Tax=Revenue Spending= Expenditures Proportional Taxes Progressive Taxes Regressive Taxes Income Tax Pay-As-You-Can Taxation Tax Withholding Tax Brackets Excise Tax Estate Taxes Gift Taxes Import Taxes Taxes Is the primary way that the government collects money. Gives the government money it needs to operate. A tax for which the percentage of income paid in taxes remain the same for all income levels. A tax for which the percent of income paid in taxes increases as income increases, A tax for which the percent of income paid in taxes decreases as income increases. Generates the most revenue for the government. Income taxes are collects throughout the course of the year as individuals earn income. Process by which employers take tax payments out of an employee s pay before they receive it. Income tax is a progressive tax Tax on the sale or production of a good. Range from gasoline to telephone services. Tax on the estate, or total value of the money and property, of a person who has died. Paid before inheritors receive their share. Tax on the money or property that one living person gives to another. Taxes on imported goods, tariffs

6 Is this counted in GDP? For each of the following, write yes if it is counted in U.S, and no if it is excluded. Then write a brief reason explaining your answer. 1. Income received from the sale of your Apple stock. 2. An increase in business inventories. 3. The services you provided when you painted your bedroom. 4. A farmer s purchase of a used tractor. 5. The federal government s purchase of new desks for their office workers. 6. A house built this year. 7. The lunch you purchased today at a restaurant. 8. The commission earned by a real estate agent when she sold a ten-year-old home. 9. A homebuilder s purchase of new tools. 10. A car produced in Mexico by an American-owned firm. GDP Gross Domestic Product GDP does not include 2 Ways to calculate GDP Nominal GDP Real GDP GDP Is the dollar value of all final goods & services produced within a country s borders in a given year. Durable goods goods that last for a relatively long time like refrigerators Non-Durable goods goods that last a short time like food and light bulbs 1. Intermediate goods -goods used in the production of final goods and services. 2. Used goods 3. Black market goods 4. Non-market activities taking care of kids, mowing lawn, car washing 5. Imported goods 6. Financial assets bonds, stocks, transfer payments Expenditure Approach Total annual expenditures on four categories of final goods or services. GDP = C+I+G+X-M C=Consumer goods and services I= Business and Investments G= Government X=Exports M= Imports Income Approach Calculate GDP by adding up all the incomes in the economy. Current GDP is GDP measured in current prices. It does not account for price level increase from year to year. Is GDP expressed in constant, or unchanging dollars.

7 Foldable Cyclical Seasonal Structural Frictional Causes of structural unemployment Full Employment Underemployment People without jobs who want and need to work. -Even in good times unemployment exists and will impact a percentage of a population. 1. The development of new technology: New tech can result in job loss. Ex.Typwriters 2. The discovery of new resources. Ex. Whale oil 3. Changes in consumer demand: If a product falls out of favor a company can fail or shift production causing unemployment. 4. Lack of education can lead to unemployment because basic skills might be lacking and a worker can not do a job. 5. Globalization: Because the economy has become a global economy jobs have been lost for reasons such as a factory being moved to take advantage of cheap labor in another country. The level of employment reached when there is no cyclical unemployment. Frictional, seasonal, and structural unemployment will exist but unemployment should be no more that 4 to 6 percent. A worker doing a job they are considered over qualified for or a worker working part time when they desire to work full time is considered underemployed. Underemployed workers are not counted against full employment.

8 Inflation Vocabulary Inflation Inflation -general increase in prices. Prices rise, the same amount of money buys less Nominal number: a number that has not been adjusted for price level changes. Inflation: a sustained increase in an economy s overall price level. Inflation Rate: the percentage change in the price level from one time period to another. Real Number: a number that has been adjusted for price level changes. Deflation: A sustained decrease in an economy s overall price level. Price Index: a measurement used the determine price level changes. Kinds of Inflation How do you measure Inflation? Consumer Price Index Or GDP Deflator Demand-pull inflation caused by an excess of total spending beyond the economy's capacity to produce Cost-Push inflation (supply-side) caused by an increase in per- unit production costs ( a negative supply shock) a measure estimating the average price of consumer goods and services purchased by households. measures a price change for a constant market basket of goods and services from one period to the next within the same area (city, region, or nation). -calculate the change in the CPI from year to year to determine the inflation rate. Measures the cost of all goods and services produced domestically; compares these cost to the cost of the same goods and services in a base year,

9 Kinds of Inflation Which of these situations describes demand-pull inflation and which is supply-side (cost-push)? 1. After World War II high demand but limited supply led to a 30%increase in prices. Losers: Unexpected Inflation: winners and losers Fixed-nominal income receivers- receive payments with increasingly lower real values Savers any wealth held as cash will lose value. Even wealth held in bank CDs or savings account will probably not keep up with inflation. 2. In 1972, the OPEC nations limited the supply of foreign oil to the United States, driving up all oil prices. 3. The cost of raw materials rises in most industries, increasing cost for producers, who then raise prices on their goods. 4. When a country runs out of money, they solve this problem by printing more currency to pay their debts. 5. Consumers expect inflation to occur in the near future, do they begin to spend more and more money today, causing prices to increase. 6. In the 70s, workers gained increases in wages, during a period of declining productivity. The increased costs to producers resulted in increased prices to consumers. Winners: Calculations Lenders (creditors) receive payment with lower real values than expected Employees (in the short-run) while nominal wages are fixed and real wages are failing Borrowers (debtors) can pay back loans with cheaper dollars Firms ( in the short-run) if real wages are failing Calculating a Price Index: Current-year cost of market basket Base-year cost of market basket Calculating Percentage Changes: New number-old number Old number Calculating real number, for example, real GDP Nominal GDP Price index =Real GDP

10 Economic Goals What are the nation s economic goals and how do we measure them? Economic goals include 1. full employment, which is measured by the unemployment rate 2. stable prices, measured by indices such as the Consumer Price Index and 3. economic growth, measured by real gross domestic product (GDP). Economic Goals Unemploymen t Rate 4% to 6% Recession High Above 6% Expansion What Keeps the Business Cycle Going In a Positive Direction? Business Investment Interest Rates and Credit: Low interest rates help expansion! Consumer Expectations: Confidence must exist! External Shocks: You don t want surprises, especially bad ones! Inflation Rate 2% GDP Growth 2% to 3% Deflation Declining CPI GDP declining Monetary Policy (FED expands money supply) = Easy 1. Lower Discount Rate 2. Lower Reserved Ratio 3. Buy bonds on the Open Market Operations Inflation Above 2% Monetary Policy (FED contracts money supply) = Tight 1. Higher Discount Rate 2. Higher Reserved Ratio 3. Sell bonds on the Open Market Operations Monetary Policy Easy Money Policy Tight Money Policy Actions by the Federal Reserve System to expand or contract the money supply to affect the cost and availability of credit. Monetary policy resulting in lower interest rates and greater access to credit; associated with an expansion of the money supply. Monetary policy resulting in higher interest rates and restricted access to credit; associated with a contraction of the money supply.

11 Fiscal Policy Fiscal Policy Use of government spending and revenue collection measures to influence the economy. Fiscal Year The budget for the federal government beginning on October 1 st Government Income (Revenue) Personal Income Tax 38% Social security, Medicare, and unemployment 27% Borrowing to cover deficit 20% Economic Goals Recession Expansion Government Spending (Expenditures) Social security, Medicare, Medicaid 41% National Defense 23% Social Programs 22% Net interest on debt 6% Unemploymen t Rate 4% to 6% High Above 6% Deficit A situation in which the budget expenditures exceed revenues. Spends more than it makes. Inflation Rate 2% Deflation Declining CPI Inflation Above 2% Debt The total amount of money the federal government owes to bondholders GDP Growth 2% to 3% GDP declining Fiscal Policy = Expansionary 1. Increase government spending 2. Lower Taxes 3. Increase output Fiscal Policy = Contractionary 1. Decrease government spending 2. Higher Taxes 3. Decrease output Expansionary Contractionary Keynesian Economics Multiplier Raise government spending or transfer payments and/or decrease taxes, moves budget toward a deficit. Lower government spending or transfer payments and/or raise taxes, moves government budget toward a surplus. Government spending and taxation policies to stimulate the economy. Change in overall spending caused by a change in investment spending. Government spending causes greater national output. = Increase GDP