Monday, April 30, 2018

Unit 4: Expansionary vs. Contractionary Monetary Policy

Expansionary vs. Contractionary Monetary Policy

Expansionary Monetary Policy – “Easy” Money (Recession)

-       Buy Bonds (Big Bucks)
-       RR ↓
-       DR ↓
-       FFR ↓
-       i ↓
-       Ig ↑
-       AD ↑
-       MS ↑
-       $ depreciate
Contractionary Monetary Policy – “Tight” Money (Inflationary)

-       Sell Bonds
-       RR ↑
-       DR ↑
-       FFR ↑
-       i ↑
-       Ig ↓
-       AD ↓
-       MS ↓
-       $ appreciate

Unit 4: Money Creation Process

Unit 4: Money Creation Process

1.)  $1000 in cash deposited into a checking account
2.)  $1000 Fed purchase of Bonds from the public (deposited into a checking account)

                                         ↓                                                                               

No immediate change in MS
Immediate increase in MS of $1000

                                                                                

Assets
Reserves - $1000
Liabilities
DD - $1000


Required Reserves = $100 (.10 x $1000 deposit)
Single Bank: Amount of money single bank can create (loan out) = ER

 Actual Reserves - Required Reserves = Excess Reserves

$1000 - $100 = $900

Banking System: can create by a multiple of its initial EXCESS RESERVES

Monetary Policy = 1/RR

1/.1=10

System New $ = Deposit Multiplier x Initial Excess Reserves

10 x $900 = $9000

Total change in money supply as result of deposit

initial deposit + banking system created money = Total change in MS


Unit 4: Money


April 9, 2018


Unit 4: Money


Uses of money

1.    Medium of exchange - barter/trade

2.    Unit of account - economic value

a.    Am I getting my money’s worth?

3.    Store of value – what is the money’s value over time?


Types of money

1.    Commodity money – a product

a.    EX: golden silver

2.    Representative Money – Money that has no value

a.    EX: IOU’s

3.    Fiat Money – it is money because the government says so.


Characteristics of Money

1.    Durability – Able to last / withstand

2.    Portability – carry money from place to place

3.    Divisibility – money can be divided into smaller units

4.    Uniformity – same or identical

a.    EX: old money is the same as the new money

5.     Scarcity

6.    Acceptability


Money Supply – Monetary Policy controlled by the Fed. Government

-       M1 Money: Cash, currency, coins, checkable or demand deposits(checking account)

o   75% of businesses

o   Traveler’s check

-       M2 Money: M1 Money + savings account

-       M3 Money: M2 Money + Money Market Accounts + CD’s


Liquidity – Easily to convert to cash
Prime Rate: Interest rate that banks charge their most credit worthy customers.
Balance Sheet:
  • summarizes the financial position of a bank at a certain time

ASSETS:
- RR (Required Reserves): % of DD in vault
- ER (excess Reserves): remaining of DD for loans
- Property
- Securities or Bonds (investments)
- Loans
LIABILITIES:
-DD (Demand Deposits); Checkable Deposits
- Net Worth (Owners Equity) bank owners wealth


Assets = Liabilities + Net Worth
DD (demand deposits) = RR (required reserves) + ER (excess reserves)
MM (money multiplier) = ER (excess reserves) x [1/RR (required reserves)]

Fractional Reserve Banking System: Where a fraction of the total money supply is held in reverse as currency.

Basics: How Do Banks Get Money?

- From the public as deposits. The public wants safety and sometimes a return in the form of interest rates.
- Since the deposits are the property of the public, banks must record them as "liabilities" for the bank and are labeled as "demand deposits". they are also known as "checkable accounts" but that tern is being used less with the demise of "checkbooks".
- Banks, once in operation, can invest funds in the form of Federal Bonds, purchased from the Fed. The bonds earn the bank interest rate. The bond amounts are "assets" for banks.

What Do Banks Do With The Money?

- lend it the public in order to profit from the interest charges on the loans. This money creates a "money multiplier" or "monetary multiplier".

Do Banks Lend All of the Money? No

- Not all of the Demand Deposits, Since some of the public comes to the bank each day and wants to withdraw some of the Demand Deposits, banks must keep some cash "in the vault". This "reserve" is used to satisfy withdrawal requests.
- Banks that belong to the Federal Reserve System must keep a "Required Reserve" percentage set by the Fed. the Required Reserve is approximately 10? of Demand Deposits, and since almost all banks in the US are part of the Fed System, this has become the national standard.
- The remaining amount becomes the "excess reserves". The excess are then used by the banks as loans to the public.
- Banks can lend all of the Bond Assets they hold and so not have to put any percentage into the Required Reserves.

What Happens to the Loans?

- When a person borrows from a bank it will be assumed that the money is spent somewhere. The next assumption is that the funds end up in a bank account as someone else's checkable Deposits in a second bank. The second bank then pulls out the Required Reserves, The remaining Excess Reserves become a new loam which another person can use the money ends up in a third bank. The process "multiplies".
- Note however, that with each new loan, some is removes and held a Required Reserves. The loam amount will shrink with each new loan. How many times can the process occur?
- No one knows at which point any given amount of deposits shrink to a point where borrowing will end, but estimates are made using the "money multiplier". the formula is based on the amount being drained out by the Reserve Requirement. The greater the Reserve Requirement, the quicker the loan amount will shrink and end the line of loans.
- The general formula is given as 1/rr, with "rr" standing for the Required Reserve percentage, known here as the reserve ratio. If the rr is 10%, then every original loan of 1 dollar will create 10 dollars of loans in the banking system (1/.1). A 5% rr gives a multiplier of 20(1/.05) and a reserve of 20% lowers the multiplier to only 5(1/.20).

AP and Bank T-Accounts

- Banks keep all of the accounting for this lending in a T-Account of Assets and Liabilities.
- The Assets and Liabilities are always equal to show bank solvency,
- The T-Account is a chart, with Assets on the Left and Liabilities of the Right.

Wednesday, April 4, 2018

Unit 3: Fiscal Policy

March 29, 2018

Fiscal Policy

Fiscal Policy
  • Changes in the expenditures or tax revenues of the federal government.
  • There are 2 tools of fiscal policy
    1. Taxes: Government can increase or decrease taxes (not at the same time)
    2. Spending: Government can increase or decrease spending
  • Fiscal policy is enacted to promote out nations economic goals, full employment, price stability, economic growth.
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)

  • Borrowing Money
    • The Government can borrow from:
      • Individuals
      • Corporations
      • Financial Institutions
      • Foreign Countries
Fiscal Policy Two Options
  1. Discretionary Fiscal Policy (action)
    • Expansionary Fiscal Policy = think deficit
    • Contractionary Fiscal Policy = think surplus
  2. Non - Discretionary Fiscal Policy (no - action)
Discretionary vs. Automatic Fiscal Policies
  • Discretionary Fiscal Policy
    • Increasing or decreasing government spending and / or taxes in order to return the economy to full employment. Discretionary involves policy makes doing fiscal policy in response to an economic problem.
  • Automatic Fiscal Policy
    • Unemployment compensation and marginal tax rates are examples of automatic policies that help mitigate the effects recession and inflation. Automatic fiscal policy takes place without policy makers having respond to current economic problem.
Contractionary vs. Expansionary Fiscal Policy
  • Contractionary Fiscal Policy
    • Policy designed to decrease aggregate demand
    • strategy from controlling inflation
    • Inflation is countered with contractionary policy 
      • decrease government spending (G↓)
      • increase taxes (T↑)
  • Expansionary Fiscal Policy
    • Policy designed to increase GDP, combatting a recession, and reducing unemployment
    • Recession is countered with expansionary policy
      • increasing government spending (G↑)
      • Decrease taxes (T↓)
Automatic or Built in Stabilizers
  • Anything that increases the government's budget deficit during a recession and increases its budget surplus during inflation without repairing explicit action by policy makers. 
  • Economic Importance
    • Taxes reduce spending and aggregate demand
    • Reductions in spending are desirable when the economy iv moving toward inflation.
    • Increases in spending are desirable when the economy is heading toward recession.
  • Transfer Payments
    • Welfare Checks
    • Food Stamps
    • Unemployment Checks
    • Corporate Dividends
    • Social Security
    • Veteran's Benefits

Unit 3: Multipliers

March 27, 2018

Multipliers

The Spending Multiplier Effect
  • An initial change in spending (C, Ig, G, Xn) causes a larger change in aggregate spending, or Aggregate Demand (AD)
Multiplier = (Change in AD)/(Change in Spending)

Multiplier = (Change in AD)/(Change in C, Ig, G, or Xn)
  • Why does it happen?
    • Expenditures and income flow continuously which sets off a spending increase in the economy.
Calculating the Spending Multiplier
    • The Spending multiplier effect 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 leaving 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.

Unit 3: Consumption and Savings

March 23, 2018

Consumption and Savings

Disposable Income (DI)
  • Income after taxes or net income
DI (disposable income) = Gross Income - Taxes
  • 2 choices
    • With disposable income, households can either:
      1. Consume: spend money on goods and services
        • Consumption
          • Household Spending
          • The ability of disposable income: The amount of disposable income and the prosperity to save
          • Do households consume if DI = 0?
            • Autonomous consumption and dissaving
      2. Save: save money on goods and services
        • Saving
          • Household not spending
          • The ability to save its constrained by: The amount of disposable income and the propensity to consume
          • Do households save if DI = 0?
            • No
APC and APS
  • APC: Average propensity to consume
  • APS: Average propensity to save
Average Propensity to consume (APC) + Average Propensity to save (APS) = 1

Average Propensity to consume (APC) > Dissaving

- Average Propensity to save (APS) = Dissaving

MPC and MPS
  • Marginal Propensity to consume (MPC): fraction of any change in disposable income that is consumed.
    • % of every extra dollar earned that is spent
  • Marginal Propensity to save (MPS):  fraction of any change in disposable income that is saved.
Marginal Propensity to consume (MPC) + Marginal Propensity to save (MPS) = 1

Marginal Propensity to consume (MPC) = (Change in Consumption)/(Change is disposable income)

Marginal Propensity to save (MPS) = (Change in savings)/(Change in disposable income)

Unit 3: Interest Rates and Investment Demand

March 20, 2018

Interest Rates and Investment Demand

  • Investment:
    • Money spent or expenditures on:
      • New plants (factories)
      • Capital Equipment (Machinery)
      • Technology (hardware and 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 rate, then invest
        • If expected return < interest rate, then do not invest
  • Real (r %) v. Nominal (i %)
    • Nominal is observable rate of interest. real subtracts out inflation (𝝅 %) and is only known ex post factor
    • How do you compare the real investment decision?
      • r % = i % - 𝝅 %
    • What then, determines the cost on investment decision?
      • 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.
      • Conversely, there are few investments that yield high rates of return, and may the yield low rates of return.

Unit 3: The AS/AD Model

March 9, 2018

The AS/AD Model

  • The equilibrium of AS and AD determines current output (GDPR) and the price level (PL).


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

Changes (  ⃤  ) in AD
  • ⃤⃤⃤   Consumption (C)
  • ⃤⃤   Gross Private Investment (Ig)
  • ⃤⃤⃤⃤   Government Spending (G)
  • ⃤   Net Exports (Xn)

  • Increase in AD



  • Decrease in AD

Changes (  ⃤  ) in SRAS
  • ⃤⃤   input prices
  • ⃤   Productivity
  • ⃤   Legal - Institutional Environment

  • Increase in SRAS

  • Decrease in SRAS

Three Ranges of Aggregate Supply


  • Horizontal or Keynesian Range
    • Lot of unemployed resources
    • a recession of depression can occur
    • includes only levels of real output that are less than the full-employment output
  • Intermediate Range
    • Resources are getting closer to the full-employment level which creates upward pressure on wages and price
  • Vertical or Classical Range
    • When real GDO is at a level with unemployment below the full employment level and where any increase in demand will result in only an increase in price
    • The economy is unable to produce anymore goods and services for a sustainable period of time.

Tuesday, April 3, 2018

Unit 3: Aggregate Supply

March 6, 2018

Aggregate Supply



  • The level of supply of Real GDP (GDPR) that firms will produce at each Price Level (PL).
Long-Run vs. Short-Run
  • Long-Run: Period of time where input prices are completely flexible and adjust to changes in the price level.
    • The level of Real GDP supplied is independent of the price-level.
  • Short-Run: Period of time where input prices are sticky do not adjust to changes in the price level.
    • The level of Real GDP supplied is directly related to the price-level.
  • Long Run Aggregate Supply (LRAS): marks the level of full employment in the economy. (analogous to PPC)

Full Employment of graph: FE, Yf, Y*

  • Short Run Aggregate Supply (SRAS): Because input prices are stick in the short run, the SRAS is upward sloping.

Changes in SRAS
  • An increase in SRAS is seen as a shift to the right. SRAS→
  • A decrease in SRAS 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)

Determinates of SRAS (all of the following affect unit-production cost):
  • Input prices
    • Domestic Resource Prices
      • Wages (75% of all business costs)
      • Cost of capital
      • Raw Materials (commodity prices)
    • Foreign Resource Prices
      • Strong $ = lower foreign resource prices
      • Weak $ = higher foreign resource prices
    • Market Power
      • Monopolies and cartels that control resource control the price of those resources.
    • Increases in Resource Prices = SRAS←
    • Decrease in Resource Prices = SRAS→
  • Productivity
    • Productivity = (total output)/(total input)
    • More productivity = lower unit production cost = SRAS→
    • Lower Productivity = higher unit production cost = SRAS←
  • Legal-Institutional Environment
    • Taxes and subsidies
      • Taxes ($ to government on business increase 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: Aggregate Demand

March 5, 2018
Aggregate Demand

Aggregate = total



  • AD is the demand by consumers, businesses, government, and foreign countries.
  • Changes in price level causes movement along the curve not shift of the curve.
  • Shows the amount of Real GDP that the private, public, and foreign sector collectively desire to purchase at each possible price level.
  • The relationship between the price level and the level of Real GDP is inverse.

3 reasons why AD is downward sloping
  1. Wealth Effect
    • Higher prices reduce purchasing power of $.
    • This decreases the quantity of expenditures.
    • Lower price levels increase purchasing power and increase expenditures.
    • Example: If the balance in you bank was $50,000 but inflation erodes your purchasing power, you will likely reduce your spending.
  2. Interest Rate Effect
    • As 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.
    • Example: Increase in prices leads to an increase in the interest rate from 5%-25%. You are less likely to take out loans to improve your business.
  3. Foreign Trade Effect
    • When US price level rises, foreign buyers purchase fewer US goods and Americans buy more foreign goods.
    • Exports fall and imports rise causing real GDP demanded for fall (Xn decreases)
    • Example: If prices triple in the US, Canada will no longer buy US goods causing quantity demanded of US products to fall (AD).
Determinates of AD
  • Consumption (C)
    • Consumer Wealth (boom in stock market)
    • Consumer Expectations (people fear a recession...)
    • Household Indebtedness (more Consumer debt)
    • Taxes (decrease in income taxes...)
  • Gross Private Investment (Ig)
    • Real Investment Rates (price of borrowing money)
    • Future business Expectations (high expectations...)
    • Productivity and Technology (new robots...)
    • Business Taxes (higher corporate taxes means...)
  • Government Spending (G)
    • (War...)
    • (Nationalized Health Care...)
    • (Decrease in defense spending...)
  • Net Exports (Xn) = Exports - Imports (X-N)
    • Exchange Rates (if the US dollar depreciates relative to the euro...)
    • National Income compared to abroad (if a major importer has a recession...) (if the US has a recession...)

"If US gets a cold, Canada gets pneumonia."


Unit 7: Comparative and Absolute Advantage

Unit 7: Comparative and Absolute Advantage - Absolute: The producer that can produce the most output or requires the least amount of inpu...