Economics

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Velocity

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Average number of times per year a dollar is spent on a good or service that is part of GDP.

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Quantity Theory of Money

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The view that the velocity of currency is stable or constant.

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Equation of exchange

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M*V = P*Y

M= money supply
V= velocity
P= price level
Y= real GDP

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Classical School of Macroeconomice Thought

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Any deviation of real GDP from long-run equilibrium is extremely short term.

Prices adjust rapidly so that the economy will return to long-run equilibrium in two years or less

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Monetarists argued for

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small, predictable increases in the money supply

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____________, the most famous monetarist asserted that the velocity of currency was predictable, if not stable.

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Milton Friedman

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Most people today believe that the velocity of currency is not predictable enough to...

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be able to reach target levels of nominal GDP, Real GDP and the price level if a central bank always increases the money supply by a small predictable amount especiallly when major shocks hit the economy

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Bracket creep

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Some taxpayers could move into a higher tax bracket on last dollars earned if they recieve an increase in nominal income but not an increase in real income. Thus they have a higher real tax liabilities but the same real income

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Menu costs

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Costs of changing preices (i.e negotiating, strategizing)

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Some costs of inflation

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1. Bracket creep
2. Menu costs
3. Arbitrary Redistribution of Purchasing power between lenders and Borrowers when Actual Inflation is Greater than or less than its expected value

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actual inflation is greater than expected

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lender loses borrower gains

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actual inflatioon is less than expected

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Lender gains borrower loses

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MAcroeconomic goals of government policy

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1. Real GDP growth
2. Low unemployment rates
3. Price stability or low inflation

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Before the great depression government policy goals were mainly

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1. to provide goods and services that people believed were underprovided by the private sector
2. to have a balanced budget

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budget deficit

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G+ TR -T

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a Budget deficit less than zero is called a

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Budget surplus

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During the 1920s what factors led to the most significant downturn in US history?

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bank failures, stock market crash in 1929, crop failures and other factors

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Contractionary gap

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If the economy was initially in long-run equilibrium before the decrease in AD, at the new short-run equilibrium, the economy would be in a contractionary gap.

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Keyned and Keynesian economics

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observed that wages and salaries are very slow to decrease in a downturn because most employers lay off workers rather than use across the board pay cuts

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Price levels fall slowly in a downturn due to

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Wage rigidity

Thus SRAS may not shoft outward enought to close a contractionary gap
The economy may get stuck at a lower level or real GDP- take way too long to return to Y* w/ out policy changes

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Fiscal Policy tools

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1. Increase(decrease) Government Purchases
2. Increase(decrease) taxes
3. Increase(decrease government transfer payments

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To increase real GDP the government could

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Increase Government purchases
Decrease taxes
Increase Government Trasfer payments

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Analogy : Throwing a pebble into the ocean maked a very small splash. A larger meteorite makes a much larger splash. Is the New Deal effort or the WWII effort more like the meteorite?

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WWII- Meteorite

New Deal-pebble

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Macroeconomic Policy goals for Monetary policy

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1. price stablility or low inflation
2. real GDP growth
3. low unemployment rates

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Benefit of monetary policy

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Much faster to recognize problems(s),
debate and impliment solution(s).

You don't need to go thru House, Senate , WHite house

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Benefit of Fiscal policy

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Once policy change has been made, Impact on the economy is usually faster

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Required reserves ratio

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percentage of deposits that banks must hold to guard against unforseen withdrawls

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Discount ratio

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interest rates that the Fed charges with loaning to troubled banks

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Open MArket Operations and the Federal Funds Rate

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the above interest rate, the one that the fed is most interested in when the borrowing bank needs reserves to meet reserve requirements. the loans are frequently short term

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Expansionary POlicies include( to increase real GDP)

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Buy bonds in open MArket operations to lower Fed. Funds rate

Decrease discount rate

Decrease rrr

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Contractionary policies would include( to lower real GDP)

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sell bonds in open MArket operations to raise Fed. funds rate

raise discount rate
raise the rrr

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To be considered unemployed in Bureau of Labor statistics a worker must be out of work and either

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1. have sought employment in the previous four weeks or

2. be wiating to be recalled after a layoff

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discouraged worker effect

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unemployed workers counted as " not in labor force" rather than unemployed because they gave up looking for a job ( did not seek job in last 4 weeks)
- increases during downturns
- means that unemployment data understate severity of downturns

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Frictional unemployment

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switching jobs, job search, relocation

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Structural unemployment

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mismatch between skills of workers and skills sought by employers

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cyclical unemployment

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increases during recessions, decreases during booms

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Natural rate of unemployment u*

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u*= frictional + structual unemployment

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total rate of unemployment

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frictional + structural + cyclical

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central bank

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organization charged with oversight of banking system and in charge of regulating money supplu through monetary policy

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Monetary policy

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setting money supply and interest rates through policy tools

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Federal reserves bank ( the FED)

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the central bank in the United States

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Federal Open Market Committee

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Twelve member committee (7 members of board of Governors, 5 regional bank Presidents) setting monetray policy at the Fed in the USA

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The Phillips curve was originally interpreted as a...

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menu of policy choices

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sacrifice ratio

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employment ( or output) loss associated with a one-percentage-point reduction in the rate of inflation

Ub- UA / Ib-IA

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sacrifice ration equals

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1/ [ slope of the short run Philips curve]

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an increase in AD causes a move to the

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Northwest along a given SRPC

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A decrease in aggregate demand causes a move to the

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SOutheast along a given SRPC

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why did the break down of the Philips curver in the 1970s occurr?

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* Previous results just a coincidence without economic significance

* AS shocks shft the short run Philips Curver

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How are prices and inflation related?

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Positively, If inflation goes up Prices go up

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How are real GDP and unemployment rates related?

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Negatively, If output increases unemployment rates go down

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If Y > Y* then

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U< U*