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23 Cards in this Set
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Bohm-Bewark: Average Period of Production, Implications on Interest Rates |
A. Average Period of Production Ex: Suppose to produce aton of wheat you needed: workers, tractor(made 5 years ago) and tool (made twoyears ago) T0 = labor that is work now A = # of hours worked now T2 = tool that was made two years ago B = how many hours it took to make that tool T5 = tractor that was made 5 years ago C = how many hours it took to make that tractor AVG Period Production Formula = T0*A + T2*B + T5*C/ A+B+C Example: 8 hours now 5 hours of tool that was made 2 years ago 2hours using a machine that was made 5 years go AVGPP = 0*8+ 2*5 + 5*2/ (8+2+5) AVGPP = 1.33 hrs - on average, this is the age of the labor. B. Implications of Productivity a. The higher the period of production, the firm is using more complex machines. (it takes longer to make complex machines so that increases the value) C. Implications of Productivity a. Higher Period of Production = Using more complicated machines b. More Machines = More productivity D. Implications on interest Rate Firms Are Willing To Pay a. Firms with higher AVGPP will produce more & they will make more profit. b. If firms are profiting more, they are willing to accept a higher interest rate. c. Therefore, AVGPP determines interest rate. |
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Bohm-Bewark's Interest Rates: Positive Time Preference |
Lending can only take place if it is acceptable to both groups. Households save money; as a household you could spend money now or later. Positive Time Pref: Youprefer present consumption over future consumption; therefore, you are a borrower. a. You borrow if you think your earning power will be more in the future. -Ex: Going to college. You borrow money now to increase your earning power by getting a degree. b. There are more borrowers then lenders |
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Bohm-Bewark's Interest Rates: Negative Time Preference |
On average, there are more positive time preference If there were the same people with positive and negative time preference, they would help each other out. Think about it: If there is only one borrower and one lender in the world, then the lender will lend his money without any interest. Just for the sake of helping. But, if there are two borrowers and one lender, they will compete with the lender for the money by outbidding each other offering interest rates. Negative TimePreference: People who prefer future consumption than now - You are delaying your consumption now to consume later. -Therefore, lenders pay you interest to reward them for post-poning consumption Ex: Saving for retirement: you postpone your consumption now and you get interest on your money; maybe mutual funds or bonds. |
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Bohm-Bewark's Interest Rates: Why do we have interest rates? (Lack of WP, Current Needs Mr Pressing, Uncertainty of Future Needs) |
To convince people with negative time preference to post-pone consumption, we reward them with paying interest rate. - Quantity of Lenders < Quantity of Borrowers -To get them to become lenders, you offer them interest A. Lack of Willpower a. You need to have to have the willpower to delay consumption. People borrow things they cant afford and they don’t have the willpower. B. Current needs are more pressing that future needs a. You concentrate on things that are immediate instead of things in the future - "I need that now" C. Uncertainty about Future Needs a. I have an idea about future needs but they are NOT CERTAIN. D. We need to find an interest rate that is acceptable to both borrowers and lenders. a. It needs to be in equilibrium - Equilibrium: amount borrowers = amount of lenders |
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Wicksell's View of The Business Cycle: Interest Rates–Long-Run and Short-Run |
-Bohm-Bewark's AVGPP only accounts for natural interest rates (long-run rates) and not market interest rates (short-run rates) A. Bohm-Bewark's Natural Interest Rate(Bohm-Bewark) (long-run rate) a. AVGPP: Interest borrowers are willing to pay - higher productivity = higher interest rate payed b. Time Preference: Interest rates lenders are willing to pay -Positive Time Pref = borrowers -Negative Time Pref = lenders BANKS DO NOT PLAY ROLE IN NATURAL INTEREST RATE B. Wicksell's Market Rates (short-run) - determined by bank's willingness to lend a. Ifthey lend more, market interest rate goes down. -If borrowing cost is less, people are more likely to borrow and invest money. b. Ifthey lend less, market interest rates go up -if borrowing cost is high, people are not as likely to borrow money and invest. THEREFORE, BANKS CAUSES RECESSIONS AND DEPRESSIONS |
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Wicksell's View of The Business Cycle: Expansion Phase |
A. Increasedbank lending pushes market rates below natural rate and this causes economy to EXPAND - Low rates will cause investments to go up because firms can borrow for less. Since interest is the cost of money. -More projects will become profitable and investments take place. - Investment Rule: rate of profit has to be higher than interest rate B. When the investments start producing goods and people start buying goods and services, money demand increases interest rates. - At this point, people see the profitability and now there is the demand for money is more than the supply for money. -naturally, rates will increase because investors will start outbidding each other. C. The expansion will stop when market rates = natural rates |
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Wicksell's View of The Business Cycle: Contraction Phase |
A. Decreased bank lending pushes market rates ABOVE natural rate and this causes the economy to CONTRACT -High rates will cause investments to go down because cost of borrowing is high. -Projects are not as profitable now because of high interests; investments will decrease and economy will contract -GDP decreases B. Money demand is now less than the supply and interest rates will decrease - investments will decrease C. The contraction phase will stop when market rates = natural rates. |
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Irving Fisher: Real Interest Rate |
a. Nominal Rate: interest rate not adjusted for inflation b. Real rate: interest rate adjusted for inflation
A. Fisher Equation Real Rate = Nominal Rate - Inflation Rate Ex: Suppose nominal interest rate is 10% and inflation is expected to be 3% in the next year, what is the real rate? Real Rate = 10%-3% Real Rate = 7% |
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Irving Fisher: Equation of Exchange and Quantity Theory of Money |
M*V= P*Y M = Money supply V = circulation/velocity of money (How fast it goes) P = Average price level of all goods Y = Real GDP b. Quantity Theory of Money -In the long run, changing money supply does not change money velocity. A increase of money supply 10% does not change money velocity
-In the long run, changing money supply does not change does not change output (Y) Conclusion: Changes in Money supply changes prices proportionally If money supply increases by 10% , price increases by 10% |
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Keynes: Keynesian System– Short-Run Wage Ridgidity |
A. Wage Rigidity In Old System a. Statusquo was if there was a recession wages gown, costs go down and firms will hiremore workers b. Thiswas how the recession fixed it self: by hiring more workers firm will producemore GDP and recession will fix it self. B. Keyne's Wage Rigidity a. In the short-run, wages do not go down. b. Peoplebelieve wages are part of their self image, people are not willing to accept apay cut in the short run -If boss cuts your wages, you will quit. You will then try to find a better paying job.
-Then after a long time you cant get a firm to pay some one to pay what you believe you are worth, you will accept the low wages |
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Keynes: Keynesian System–Role of Expectations |
- Whenpeople make decisions, they don’t take just into consideration what ishappening now, they consider what is looking to happen to in the future - Expectations influence both consumption and investment A. Consumption a. Ifyou think your income will go up in the future, you will spend more now.\ b. Ifyou think your income will go down in the future, you will spend less now. B. Investment a. Ifyou think the firm is making more money in the future, you will invest lessnow. b. Ifyou think the firm is making less money in the future, you will invest more now. |
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Keynes: Keynesian System– The Income Multiplier (Han) |
The Income Multiplier: Ifspending in a country goes up by a certain amount, the countrys GDP goes up bya multiple of that Ex: If govt spending goes up by 20 billion. All 20 billion goes to one developer to build Wall for Trump. - Developer uses money to hire workers -Workers will use the money in their personal lives and income will go up more for the country as a whole -buying bread and the bread makers will spend that and so forth. |
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Keynes' Approach To Business Cycle: Cause of Recession |
A. Causes of Recession -Investors have animal spirit–meaning they behave like they are in a herd. -If a certain industry looks to be profitable, the herd of investors will invest in that industry in hopes of future profits. Investors will OVERREACT in the expansion and contraction phases. -2001 bubble: Investors overreacted to internet companies and industry expanded, and then overreacted to crash of companies; causing a recession -Therefore, they are IRRATIONAL. Dotcom bubble's investors abandoned simple fundamentals in investing. |
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Keynes' Approach To Business Cycle: The Expansion Phase |
Ex: Housing Bubble A. Investors are too optimistic and build way too many housing units. -they say that a few were making a profit and followed the herd. -Profits were pouring in |
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Keynes' Approach To Business Cycle: The Recession Phase |
A. Investors stop investing and Recession happens - once they have realized that they invested too much, they removed the funds and the recessions start. -based on pessimism Ex: 2006. 1. They were making a lot of money 2. Followed the herd 3. Herd realizes that profits are not likely in the future 4. Took funds away and caused a recession. |
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Keynes' Approach To Business Cycle: Reasons for Macroeconomic Stabilization (Recession Preventing) Policies–Do Not End Quickly By Themselves and Goes Deeper Because of Multiplier Effect |
- If left to its own vices, economy will fluctuate a lot and have a lot of volatility - Therefore, Government needs to fight recessions early on before they become a depression A. Recessions Do Not End Quickly By Themselves a. Government needs to institute policies to keep the economy stable
b. If we do not fight recessions, they might turn into depression c. Because of wage rigidity, recessions do not quickly end by them selves B. If the government does not fighta recession, it becomes deeper, and may turn into a depression a. Because of multiplier effect: Every decrease in spending, leads to further decrease in spending - Banks fail, unemployment are effects of depression
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Keynes' Approach To Business Cycle: Role Of AutomaticStabilizers (Preventive Strategy)–Unemployment Checks & Multiplier |
Ex: Multiplier effect 1. Lets say they were spending their money on food 2. Food industry will lay off workers because it is not getting enough money 3. If initial decrease was 500 million, by the time it ends, it will go down by a multiple of 500 million (larger than 500 million) 4. Because: Every decrease leads to another decrease A. Keynessaid "what if we found a way of decreasing the original recession byissuing unemployment money which will stimulate the economy" a. Wewant the people who were laid off to decrease their spending by less, so we putmoney in their pockets. b. It is automtic; soon as you become unemployed, you get a check. They kick in automatically, and you don’t need politicians approval. c. Happens because politicians are slow movers and by the time they reach a decision, it will be too late. |
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Keynes' Approach To Business Cycle:Fighting Recessions With Expansionary Monetary Policy |
Recession means: private sector not spending enough A. Fighting Recessions With Expansionary Monetary Policy 1. Central bank increases money supply 2. Interest rates decrease 3. Borrowing by household and investments increase. 4. Country's output (GDP) goes up |
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Keynes' Approach To Business Cycle: Fighting Recessions With Expansionary Fiscal Policy |
Recession means: private sector not spending enough A. Fighting Recessions With Expansionary Fiscal Policy 1. Cut taxes so that spending by consumers increase 2. Increased government spending Ex: Hiring school teachers, Infrastructure/Highway construction 3. Employment goes up 4. Country's output goes up as people start having money again Recessionmeans: private sector not spending enough |
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Keynes' Approach To Business Cycle: To fight deep recession, Keynesbelieved most effective policy was increasing government spending |
A. Reasons 1. Ina deep recession, if firms cannot sell what they are making, no investment is going to occur. - therefore, lowering interest rates (monetary policy) to stimulate spending will not happen because no one is willing to invest if it is not likely that businesses will invest. -Unemployed will not be helped by tax cuts 2. Therefore, government spending such as infrastructure spending will stimulate economy. FDR Example : a. FDR was elected Put people to work:
-Built more infrastructure: schools, highway -Government-made orchestras for singers -Government-made theaters for actors |
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Milton Friedman's ArgumentsAgainst Macroeconomic Stabilization Policies: Main Causes of Recessions and Unpredictable Causes |
- Friedman believed the main cause of recession is unstable money supply. It Keeps fluctuating output. - All other causes are unpredictable A. If that is the main cause, thenthe Central Bank is causing the recessions a. Therefore, strip the central bank of its monetary power. B. Other Causes of Recession Are Not Predictable a. You could cause more damage then solve them if you are wrong b. You cannot use government policy to fight recessions, it could be counter productive |
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Milton Friedman's View of Fiscal Policy: Lowering of Investment, Crowding |
A. UnlikeKeynes, he believed fiscal policy is completely ineffective. a. Hebelieved an expansionary fiscal policy increased interest rates, thus loweringprivate investment -Ex: If tax rates are cut, demand for money increases which increases interest rates; as interest rates increases, it decreases private investment. B. Any positive impact government intervention has on GDP, it cancels it self with a negative impact on GDP. Ex of Crowding Out: govtspending increases $10 billion output goes up $10b, decreases privateinvestment $10 billion (private interest rates increase) |
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Milton Friedman's Negative Tax |
- Negative tax is usedto reduce poverty and inequality. a. If people did not make much money, government should send them checks. b. If you make little money, you don’t pay taxes c. If you make less than what it costs to live, you receive income taxes |
