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89 Cards in this Set
- Front
- Back
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What are the three main concerns for economics?
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Inflation
Output growth Unemployment |
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What are the three central markets that are the focus of macroeconomics?
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Money Market
Households Firms and Government |
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Money Markets
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sometimes called the financial market—households purchase stocks and bonds from firms.
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Households
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supply funds to this market in the expectation of earning income, and also demand (borrow) funds from this market.
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Firms, government and the rest of the world
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also engage in borrowing and lending, coordinated by financial institutions.
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What is fiscal policy and who can enact it?
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The power of the federal government to tax and spend in order to achieve its goals for the economy.
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Macroeconomics
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Macroeconomics deals with the economy as a whole. It studies the behavior of economic aggregates such as aggregate income, consumption, investment, and the overall level of prices.
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Aggregate Behavior
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refers to the behavior of all households and firms together.
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Problems with fiscal policy
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Fiscal Policies include raising or lowering of taxes. If we raise taxes we are taking money out of circulation.
When one considers the impact of taxes one must look at the sector of society being impacted by the tax hike. Does it impact on the middle class, working class or upper class. |
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Benefits of fiscal policy
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Government has money to spend
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Monetary Policy
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Programs that try to increase or decrease the nations level of business by regulating the supply of money and credit.
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Monetary policy tools
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The Fed's basic monetary policy tools are:
Reserve Requirements Discount Rate Open Market Operations Printing Money |
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Reserve Requirements
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The Federal Reserve System has the power to set an amount, or percentage, of deposits that its member banks must keep in reserve at the Fed.
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Benefits and Problems of Reserve Requirements
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If the fed raises its reserve requirements then banks have less money on hand and thus have less to lend.This lowers the amount of money in circulation and could have the impact of slowing the economy and inflation. Conversely if the fed lowers the reserve requirement , banks have more money on hand, more to lend and more money goes into circulation, thus increasing spending and possibly inflation.
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Changing the discount rate
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One of the most important and publicly watched Fed actions, the discount rate is interest rate that the Fed charges banks on money the banks borrow from the Fed. Member banks borrow money from the Fed to pay out loans and other investments but they must pay a fee, the discount rate
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Benefits and Problems of changing the discount rate
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If the Fed lowers the discount rate, banks are charged less for the money they borrow and thus more people borrow. This increases the amount of money in circulation, speeds up the economy and increases inflation. Conversely, if the Fed raises the discount rate this lowers the amount of money in circulation because fewer loans are expended as the Prime goes up. This slows the economy and lowers inflation.
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How the Fed can control the banks
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The reason this can be done is because the Fed acts as the central bank and makes loans to other depository institutions. These institutions may borrow money from the Fed because they either have an unexpected drop in their member bank reserves or because they are faced with seasonal demands for loans
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Discount window
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The discount window is a teller's window at the Fed that depository institutions use to borrow member bank reserves.
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Open Market Operations
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Open Market Operations are the Fed's power to buy and sell government securities like T-Bills. The Fed uses Open Market Operations more than any other tool to regulate the economy. Most people do not pay attention to this less public action but it is very effective.
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Printing Money
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The simplest and most clear of all the Fed's operations. The government does not, as a matter of sound economic policy, print money or destroy money in order to effect changes in the economy. The power, however to do so, does exist.
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Benefits and Problems of Open Market
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If the Fed buys back bonds it is putting money into circulation because the money is going from the government to the people. So if the government buys bonds it increases inflation. Selling bonds restricts the money supply. If we do this we can lower inflation rates.
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Benefits and Problems of Printing money
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If the government prints money it increases the amount in circulation and if it destroys money it restricts the amount in circulation. This has a corresponding effect on inflation.
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What is one way of calculating Gross Domestic Product (GDP)?
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Y = C + I + E + G
where Y = GDP C = Consumer Spending I = Investment made by industry E = Excess of Exports over Imports G = Government Spending |
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Investment made by industry
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When calculating the GDP, investment means the purchases made by industry in new productive facilities, or, the process of "buying new capital and putting it to use" This includes, for example, buying a new truck, building a new factory, or purchasing new software.
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Excess of Exports and Imports
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The next component is E, or the difference between the value of all exports and the value of all imports.If Exports exceeds imports, it adds to the GDP. If not, it subtracts from the GDP. Thus, even if a nation's people work very hard to produce products for exports, but still import more than they export, the nation's GDP will be negatively impacted.
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What is the difference between final and intermediate goods?
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intermediate goods are goods that go into the production of final goods
an example of such would be the wool (intermediate good) that goes into the production of the final good (sweater) |
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Export and import Formula
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Y = C + I + (X - M)+ G
Export- X Import- M |
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What is the difference between real and nominal GDP?
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The nominal value of a good is its value in terms of money. The real value is its value in terms of some other good, service, or bundle of goods.
Examples: Nominal: That CD costs $18. Japan's science and technology spending is about 3 trillion yen per year. Real: A year of college costs about the value of a Toyota Camry. Those tickets to see Van Halen cost me three weeks' worth of food! |
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How is the official unemployment rate defined?
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the number of unemployed persons divided by the labor force, where the labor force is the number of unemployed persons plus the number of employed persons.
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Problems with the unemployment rate
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contains a couple of unavoidable complications. (1) A person who loses a 40 hour per week job, but works for one hour mowing a lawn for pay is classified as employed. (2) A person who simply expresses interest in having a job is classified as unemployed. "Discouraged workers" who have lost a job, but do not make an effort to find a new job in a given week are not classified as unemployed or even as in the labor force. Both possibilities mean that the announced unemployment rate is not as definitive as it might sound.
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The three types of unemployment
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Frictional
Cyclical Seasonal |
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Frictional Unemployment
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Frictional unemployment is unemployment that comes from people moving between jobs, careers, and locations.
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Cyclical Unemployment
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Cyclical unemployment occurs when the unemployment rate moves in the opposite direction as the GDP growth rate. So when GDP growth is small (or negative) unemployment is high.
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Seasonal Unemployment
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Seasonal unemployment is unemployment due to changes in the season - such as a lack of demand for department store Santa Clauses in January. Seasonal unemployment is a form of structural unemployment, as the structure of the economy changes from month to month.
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Causes of Unemployment
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Changes in Technology: As personal computers replaced typewriters, typewriter factories shut down. Workers in typewriter factories because unemployed and had to find other industries to be employed in.
Changes in Tastes: If bagpipes become unpopular, bagpipe companies will go bankrupt and their workers will be unemployed. |
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Embedded Economy
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An embedded economy is an economy in which economic activities occur such as, production and distribution; however other activities, which are not economic also occur. Activities such as forming friendships or helping other people may be happening, but it might just seem like the normal economic process because it is an embedded economy.
For example, if two bakers both produce wheat bread, but do not eat their own, instead they exchange bread, because they want to have a reason to be friends. This situation does not seem like economic activity, it seems like two people sharing their food. It actually is economic activity, because the two bakers are both producing and distributing their bread. |
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Disembedded Economy
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In a disembedded economy, economic activity occurs only for economic reasons, so it is the opposite of an embedded economy. Economic activity is completely independent from such institutions as family or friendship. An example, of activity in a disembedded economy is a person going to a grocery store and buying bread. There is no other institution involved in the economic process of production and distribution of the bread which is why this would occur in a disembedded economy. The producer of the bread is making the bread so that he can sell it and get money for it, the consumer is buying the bread so it will belong to him.
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Disembedded Economy and the Market pattern
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The disembedding of the market makes human social existence dependent upon this market. Income becomes dependent upon the sale of land and labor. Production becomes conditioned upon market exchange.
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4 assumptions for perfect competition
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All firms sell an identical product;
2) All firms are price takers - they cannot control the market price of their product; 3) All firms have a relatively small market share; 4) Buyers have complete information about the product being sold and the prices charged by each firm; and |
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Causes of market failure
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occurs due to inefficiency in the allocation of goods and services.
Public Good Free Rider monopoly Externalities |
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Externalities
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Positive and negative externalities: an externality is an effect on a third party that is caused by the consumption or production of a good or service
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Positive Externalities
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A positive externality is a positive spillover that results from the consumption or production of a good or service. For example, although public education may only directly affect students and schools, an educated population may provide positive effects on society as a whole.
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Negative Externalities
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A negative externality is a negative spillover effect on third parties. For example, secondhand smoke may negatively impact the health of people, even if they do not directly engage in smoking.
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Public Goods
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public goods are goods where the total cost of production does not increase with the number of consumers. As an example of a public good, a lighthouse has a fixed cost of production that is the same, whether one ship or one hundred ships use its light.
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Monopoly
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A market where one company is the sole supplier.
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Free Rider
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One who obtains benefit from a public good without paying for it directly.
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Market failure and Perfect Competition
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Market failures result from the failure of one of the assumptions basic to the perfectly competitive model
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three major roles for government according to Adam Smith
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1. National Defense- Military
2. Administration of Justice, (Law and Order) 3. Provision of Publics Goods (elementary education, transportation infrastructure: goods individuals cannot afford alone) |
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CPI
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Consumer Price Index, Consumer Price index is a measure of the total value of goods and services consumers bought.
Example:Consumers can feel this index by buying a gallon of orange juice, sodas, and a bag of mashed potato mix at a supermarket and returning to get some more the following week only to find out that they have to pay an extra $1.30 for the same items. |
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GDP Deflator
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This Index is the value of a basket of goods, services and final products produced by the entire nation. The index is a broader measure of the overall change in price than the CPI and the PPI.
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PPI
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Producer Price Index- This index measures the degree of inflation in the eyes of producers.
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Economic costs of Inflation
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Menu Costs
Misallocation of Resources Tax distortions |
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Menu Costs
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When prices are constant over long periods of time, firms benefit in that they don't need to worry about changing the prices for their output.
When prices change over time, on the other hand, firms would ideally like to change their prices in order to keep pace with the general trends in prices, since this would be the profit-maximizing strategy. Unfortunately, changing prices is generally not costless, since changing prices requires printing new menus, relabeling items, and so on. These costs are referred to as menu costs, and firms have to decide whether to operate at a price that is not profit-maximizing or incur the menu costs involved in changing prices. Either way, firms bear a very real cost of inflation. |
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Misallocation of Resources
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When inflation occurs and prices of different goods and services rise at different rates, some goods and services become cheaper or more expensive in a relative sense. These relative price distortions, in turn, affect the allocation of resources toward different goods and services in a way that would not happen if relative prices remained stable.
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Tax distortions
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In the United States, there are many taxes that do not automatically adjust for inflation. For example, capital gains taxes are calculated based on the absolute increase in value of an asset, not on the inflation-adjusted value increase. Therefore, the effective tax rate on capital gains when inflation is present may be much higher than the stated nominal rate. Similarly, inflation increases the effective tax rate paid on interest income.
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Economic Costs of deflation
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Wage cut and layoff-When revenues start to drop, companies need to find ways to reduce their expenses to meet their bottom line.
Changes in consumer spending-When the economy undergoes a period of deflation, customers often take advantage of the substantially lower prices. Initially, consumer spending may increase greatly; however, once businesses start looking for ways to bolster their bottom line, consumers who have lost their jobs or taken pay cuts must start reducing their spending as well. |
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Crowding Out
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increased government borrowing, a kind of expansionary fiscal policy, reduces investment spending.
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Crowd out Problem
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reduction in private investment t
hat occurs because of an increase in government borrowing. If an increase in government spending and/or a decrease in tax revenues leads to a deficit that is financed by increased borrowing, then the borrowing can increase interest rates, leading to a reduction in private investment. |
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Aggregate Income
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is the total income received by all factors of production in a given period.
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Consumption
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the final purchase of goods and services by individuals.
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Sticky Wages
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Bob is out every day with the other guys mowing lawns, like this gigantic one at the home of an oil billionaire. He is not sitting in an office all day thinking about whether or not to raise or lower the wages of his workers. Wages are typically only determined when he hires someone new or when he grants someone a raise.
The most economical thing Bob could do for his own business would be to lower everyone's wage by 10%. That would offset the loss in income from having fewer customers during a recession. As an alternative, he could let one or two workers go. Given these two choices, what do you think Bob's going to end up choosing? He'll let one or two workers go. The last thing he wants to do is to tell all his workers that their wages are going down. In Margie's cake business, wages are set with employment contracts, which are not easily changed. In addition, some employees are minimum wage employees. That means when economic conditions change, wages in her business don't adjust |
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Aggregate Expenditure
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Measure of national income
is the sum of consumption, investment, government purchases, and net export Used to predict future GDP as it is planned and GDP is planned and unplanned |
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Aggregate Output
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is the total quantity of goods and services produced (or supplied) in an economy in a given period.
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What is the relationship between aggregate income, aggregate output, and aggregate expen- ditures in equilibrium
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Aggregate output and aggregate income have exact equality.
Equilibrium occurs when there is no tendency for change. In the macroeconomic goods market, equilibrium occurs when planned aggregate expenditure is equal to aggregate output (income). Both Y |
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Why may aggregate consumption be more stable then aggregate income
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Aggregate consumption includes:
Household income Household wealth Interest rates Households’ expectations about the future While Aggregate Income is Only the income from production which may change |
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Leakage
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means withdrawal from the flow.When households and firms save part of their incomes it constitutes leakage.They may be in form of tax payments and imports also.Leakages reduce the flow of income.
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Injections
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Injections means introduction of income into the flow.
When households and firms borrow the savings, they constitute injections. Injections increase the flow of income. Injections can take the forms of (a) investment, (b) government spending and (c) exports |
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Leakages and Injections
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So long as leakages are equal to injections circular flow of income continues indefinitely.Financial institutions or capital market play the role of intermediaries.
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Marginal propensity to Consume
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The proportion of each additional dollar of household income that is used for consumption expenditures
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Marginal propensity to save
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It indicates the change in saving resulting from a change in income
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MPC and MPS
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MPC and MPS have an inverse relationship. Because they add up to 100 percent, as MPS increases, MPC decreases and vice versa.
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Three roles to make it money
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Medium of exchange
Store of Value Unit of value |
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Medium of exchange
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Money can be used to buy things and pay debts.
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Store of Value
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Money retains its purchasing powercan
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Unit of Value
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money is the unit in which prices are listed
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Fiat verses commodity money
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Fiat is fake, printed with no collateral
Commodity is printed but secured by some collateral such as gold |
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Money and transactions M1
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M1 is the total value of currency
Therefore M1 consists of: currency checkable deposits( transactions account) traveler's checks |
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How do private banks create money?
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Banks can create money through the accounting they use when they make loans.
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Aggregate output and money demand
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Consider an increase in aggregate output. Such an expansion can be caused by any number of factors, such as an increase in government spending, for example. This will affect the money market by affecting the demand for money. Recall from the previous lecture that an increase in aggregate output (income) will cause an increase in the demand.
Aggregate output decreases, money demand decreases, interest rates decrease |
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Demand for money and Interest rates
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As interest rates decrease, demand for money increases. vice versa When interest rates decrease, bonds become less attractive. If you are getting a lower interest rate on your investments, you are more likely to trade those investments in for hard cash.
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Automatic Stabilizers
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Automatic stabilizers are policies that work without explicit government action to reduce fluctuations in the size of a national economy due to business cycle effects.
Government welfare and unemployment insurance programs work in a similar automatic and countercyclical manner, increasing government expenditure during recessions and reducing government expenditure during expansions. |
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Deficit targeting as an automatic destabilizer
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Deficit targeting changes the way the economy responds to negative demand shocks because it does not allow the deficit to increase. The result is a smaller deficit but a larger decline in income than would have otherwise occurred.
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Positive Economics
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concerns the description and explanation of economic phenomena
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Normative Economics
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expresses value or normative judgments about economic fairness, or what the outcome of the economy or goals of public policy ought to be
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Multiplier
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The increase in equilibrium real GDP divided by the increase in autonomous expenditure.
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Multiplier effect
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The process by which an increase in autonomous
expenditure leads to a larger increase in real GDP. |
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Smith
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Thus it's clear from his writings that Adam Smith was concerned with both the normative and positive aspects of economics
Smith talks about the way in which expansion of the market allows further division of labor and thus prosperity of men Thus, sympathy is the foundation of rules and justice. Smith's arguments about moral sentiments which are based on this theory of sympathy is the foundation of modern normative economics. |
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everyone’s expenditure is someone else’s receipt
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Every transaction must have two sides
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fallacy of composition
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arises when one infers that something is true of the whole from the fact that it is true of some part of the whole
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