Econ Final

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anticpated change

Back 1

change that is forseen by decision makers in time for them to make adjustments

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unanticipated change

Back 2

change that decision makers could not reasonably foresee
-choices made prior to change did not take it into account

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aggregate demand curve

Back 3

isolates effect of prive level on quantity demanded of goods and services

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effects of the reduction in price level of goods and services

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1. increase wealth of people holding a fixed quantity of money
2. reduce real rate of interest
3. make domestically produced goods cheaper than those produced abroad

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factors that increase aggregate demand

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1. increase in real wealth
2. decrease in real rate of interest
3. optimism about future economic conditions
4. a rise in expected rate of inflation
5. higher real incomes abroad
6. a fall in the value of a nation's currency

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factors that decrease aggregate demand

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1. lower real wealth
2. an increase in the real rate of interest
3. pessimism about future economic conditions
4. a fall in the expected rate of inflation
5. lower real incomes abroad
6. a rise in the value of a nation's currency

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optimism

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stimulates current investment
increased aggregate demand

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pessimism

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pessimist about future will cut back on current spending

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consumer sentiment index

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measures whether consumers are becoming more optimistic or more pessimistic about the economy
-turns down during early stages of recent recessions

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if US dollar appreciates

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decline in net exports
-cheaper to import from foreign countries
-shifts AD curve to left

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factors increase long-run aggregate supply

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1. increase in supply of resources
2. technology and productivity improvements
3. institutional changes that improve the efficiency of resource use

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factors decrease long-run aggregate supply

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1. a decrease in the supply of resources
2. technology and productivity deteriorates
3. institutional changes that reduce the efficiency of resource use

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factors increase short-run aggregate supply

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1. fall in resource prices (production costs)
2. fall in the expected rate of inflation
3. faborable supply shocks, such as good weather or lower prices of important imported resources

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factors decrease short-run aggregate supply

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1. rise in resource prices (production costs)
2. a rise in the expected rate of inflation
3. unfavorable supply shocks, such as bad weather or higher prices of important imported resources

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long-run aggregate supply curve

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shows maximum rate of sustainable output of an economy given its current:
1. resource base
2. level of technology
3. institutional arrangements

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productivity

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average output produced per worker during a specific time period
-usually measured by output per hour worked

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long-run growth of real GDP in US

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around 3% a year

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supply shocks

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unexpected event that temporarily increases or decreases aggregate supply

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how many business cycles have there been in U.S.

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10

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1929-1933

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Real GDP fell by more than 30%

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1933

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25% unemployed

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central message of Keynes

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businesses will produce only the quantity of goods and services they believe consumer, investors, governments and foreigners will plan to buy

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primary tool of fiscal policy

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federal budget

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governments expenditures are financed by 2 factors

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1. taxes or revenues derived from other sources
2. borrowing

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balanced budget

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situation in which current government revnue from taxes, fees, and other sources is just equal to current government expenditures

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budget deficits

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situation in which total government spending exceeds total government revenue during a specific time period (usually a year)

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budget surplus

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situation in which total government spending is less than total government revenue during a time period (yr)
-allows government to reduce outstanding debt

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changes in size of deficit/surplus can be caused by 2 different sources

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1. reflect state of economy
2. discretionary fiscal policy

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discretionary fiscal policy

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change in laws or appropriation levels, that alter government revenues and or expenditures
-requires passage of tax/spending legislation
-deliberate change in tax laws and/or government spending levels

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Keynesians argument

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federal budget should be used to promote a level if total spending (aggregate demand) consistent with full-employment rate of output

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how to stimulat AD by use of budget

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1. increase in government purchases of goods and services will directly increase AD
2. changes in tax policy
-reduction in taxes increases wealth/income which stimulates higher AD

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expansionary fiscal policy

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increase in government expenditures and/or a reduction in tax rates, such that the expected size of the budget deficit expands
-Keynesians want government to enforce when exonomy below potential capacity

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restrictive fiscal policy

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reduction in government expenditures and/or an increase in tax rates such that the expected size of the budget deficit declines (or the budget surplus increases)
-Keynesians believe that a shift toward a more restrictive fiscal policy is proper prescription with which to combat inflation generated by excessive aggregate demand

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countercyclical policy

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policy that tends to move economy in an opposite direction from forces of the business cycle
-such a policy stimulates demand during contraction phase of business cycle and restrain demand during expansion phase

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money

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item commonuly used to pay for goods, services, assets and outstanding debts
performs 3 basic function
-medium of exchange
-store of value
-unit of account

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medium of exchange

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an asset that is used to buy and sell goods or services
-simplifies and reduces costs of transactions

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fiat money

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money that has neither intrinsic value nor the backing of a commodity with intrinsic value; paper currency is an example

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liquid asset

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an asset that can be easily and quickly converted to money without loss of value

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store of value

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an asset that will allow people to transfer purchasing power from one period to the next

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unit of account

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a unit of measurement used by people to post prices and keep track of revenues and costs
-good for comparisons

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M1 money supply

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sum of
1. currency in circulation (including coins)
2. checkable deposits maintained in depository institutions
3. traveler's checks

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currency

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coinds and paper bills

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checkable bank deposits

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2 types
demand deposits
other checkable deposits

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demand deposits

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non-interest-earning checking deposits that can be either withdrawn or made payable on demand to a 3rd party
widely used as means of payment
ex: check.debit card

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M1 money supply takes into account

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1. currency in circulation
2. checkable deposits (both demand deposits and interest earning checkable deposits)
3. traveler's checks

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M2 Money Supply

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includes all items included in M1 plus
1. saving deposits
2. time deposits (accounts of less than 100,000) held in depository institutions
3. money market mutual fund shares

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depository institutions

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businesses that accept checking and saving deposits and use a portion of them to extrend loans, and make investments
ex: Banks, savings and loan associations, and credit unions

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money market mutual funds

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interest-earning accounts that pool depositor's funds and invest them in highly liquid short-term securities
-because these securities can be quickly converted to cash, depositors are permitted to write checks (which reduce their share holdings) against their accounts

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credit

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funds acquired by borrowing
loan
liability

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federal reserve system

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the central bank of the U.S.
carries out banking regulatory policies and is responsible for the conduct of monetary policy

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central bank

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an institution that regulates the baking system and controls the supply of a country's money

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savings and loan associations

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financial institutions that accept deposits in exchange for shares that pay dividers
-historically, funds were channeled into residential mortgage loands, but now offer essentially same services as a commercial bank

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credit unions

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financial cooperative organizations of individuals with a common affiliation (employer/labor union, etc)
-accept deposits, including checkable deposits, pay interest or dividends on them out of earnings and lend funds primarily to members

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commercial banks

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financial institutions that offer a wide range of services
ex: checking accounts, savings accounts, and loans to their customers

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3 types included in banking industry

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commercial banks
savings and loan associations
credit unions

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major liabilities of a bank

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transaction (checking)
savings
time deposits

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bank reserves

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vault cash plus deposits of banks with Federal Reserve banks

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fractional reserve banking

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a system that permits banks to hold reserves of less than 100% against their deposits

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required reserves

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minimum amount of reserves that a bank is required by law to keep on hand to back up its deposits

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required reserve ratio

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ratio of reserves relative to a specified liability category (for ex: checkable deposits) that banks are required to maintain

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excess reserves

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actual reserves that exceed the legal requirement

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deposit expansions multiplier

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multiple by which an increase in reserves will increase the money supply
-inversely related to the required reserve ratio

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potential deposit expansion multiplier

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maximum potential increase in the money supply as a ratio of the new reserves injected into the banking system
-equal to inverse of required reserve ratio

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actual deposit multiplier is generally less than potential for 2 reasons

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1. deposit expansion multiplier will be reduced if people decide to hold the currency rather than deposit it in a bank
2. banks fail to use all new excess reserves to extend loans

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3 major centers od decision making within federal reserve

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1. board of governors
2. district and regional banks
3. federal open market committee

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board of governors

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7 members
14 yr term

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federal reserve district banks

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12 federal reserve district banks
primarily responsible for monitoring commercial banks in their regions
clearing of checks

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federal open market committtee

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a committee of the federal reserve system that establishes federal policy with regard to the buying and selling of government securities
* primary mechanism used to control money supply
*composed of the 7 members of Board of Governors and 12 district bank presidents of the Fed

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4 major tools Fed uses to control money supply

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1. establishment of reserve requirements for banks
2. buying and selling U.S. government securities and other financial assets in open market
3. volume of lonas extended to banks and other institutions
4. interest rate it pays banks on funds held as reserves

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Fed reduces reserve requirements-->

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creates additional excess reserves and induce banks to extend more loans, which will expand the money supply

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Fed purchases additional U.S. securities and other assets-->

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increases the money supply and also expands the reserves available to banks

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Fed extends more loans-->

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increase bank reserves, encouraging banks to make more loans and expand money supply

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Fed reduces the interest paid on excess reserves

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induce banks to hold less reserves and extend more loans, which expands money supply

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expansionary montary policy
4 factors Fed changes

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1. reduces reserve requirement
2. purchase additional U.S. securities
3. extend more loans
4. reduce ointerest paid on excess reserves

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restrictive monetary policy
4 factos Fed changes

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1. raise reserve requirements
2. sell U.S. securities and other assets
3. extend fewer loans
4. increase the interest paid

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Fed raising reserve requirements-->

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reduce excess reserves of banks and induce them to make fewer loans, which will contract money supply

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Fed sells U.S. securities and other assets-->

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decrease the money supply and also contract the reserves available to banks

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Fed extends fewer loans-->

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decrease bank reserves, discourage bank loans, and reduce money supply

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Fed increases interest paid on excess reserves-->

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induce banks to hold more reserves and extend fewer loans, which will contract money supply

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reserves of baking institutions composed of 2 factos

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1. currency held by the bank (vault cash)
2. deposits of the bank with Fed Reserve System

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open market operations

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buying and selling of U.S. government securities and other dinancial assets in the open market by the Federal Reserve

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discount rate

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interest rate Federal Reserve charges banking institutions for short-term loans

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Federal Funds market

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a loanable funds market in which banks seeking additional reserves borrow short term funds
(generally for seven days or less) from banks with excess reserves

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term auction facility (TAF)

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newly established procedure used by the Fed to auction credit for an 84 day period to depository institutions willing to bid the highest interest rates for the funds

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monetary base

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sum of currency in circulation plus bank reserves (vault cash and reserves with Fed)
-reflects purchases of financial assets and extension of loans by the Fed

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U.S. treasury differs from Fed reserve

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1. concered with finances of federal government
2. issues bonds to the general public to finance the budget deficits of the federal government
3. does not dtermine money supply

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federal reserve differs from U.S. treasury

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1. converened with monetary climate of the economy
2. does not issue bonds
3. controls money supply and often uses the buying and selling od bonds issued by U.S. treasury to do so

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3 factors that influence nature and meaning of the money supply figures

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1. widespread use of the U.S. dollar outside of the US
2. the increasing availability of low federal stock and bond mutual funds
3. substitution of electronic payments for check and cash

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monetarists

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a group of exonomists who believe that
1. monetary instability is the major cause of fluctuations in real GDP
2. rapid growth of the money supply is the major cause of inflation
-argue that monetary policy is primary source of economic instability and inflation

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demand for money

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curve that indicates the relationship between interest rate and quantity of money people want to hold
-inversely related

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higher bond prices-->___ interest rates

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lower interest rates

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expansionary monetary policy

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shift in monetary policy designed to stimulate aggregate demand
-injection of additional bank reserves, lower short-term interest rates and an acceleration in the growth rate of the money supply are indicators of a more expansionary monetary policy

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how Fed expands money supply

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-Fed buys additional bonds
-banking system gets supplies with additional reserves
-increases supply of loanable funds
-downward pressure on real interest rate
-aggregate demand increases

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Fed's bond purchases, creation of additional bank reserves and lower real interest rate influence goods and services by

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1. lower real interest rate make current investment and consumption cheaper
2. lower interest rate tend to cause financial capital to move abroad, the foreign exhange rate of dollar to depcriate, and net exports to expand
3. lower real interest rate will tend to increase asset prices

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restrictive monetary policy

Back 95

shift in monetary policy designed to reduce aggregate demand and put downward pressure on general level of prices (or rate of inflation)
-reduction in bank reserves, reduction in growth rate of the money supply are indicators of a more restrictive monetary policy