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152 Cards in this Set
- Front
- Back
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Economics
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studying choice in a world of scarcity
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Scarcity Principle
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we have boundless needs and wants, the resources available to us are limited, the scarcity means we have to make choices
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GDP
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Gross Domestic Product
measure of the marke value of all final goods and services produced in the domestic economy in the current period |
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Cost-Benefit Principle
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difference between benefit and cost- the net benefit- also called economic surplus
should choose actions that generate the largest economic surplus |
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Opportunity Cost
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true cost of an action, value of the next best alternative that must be foregone to undertake an activity
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4 implications of rationality
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1.cost and benefits are absolute, not proportional
2. Take proper account of opportunity cost 3. Cost already incurred or sunk are not relevant to your decision 4. rationality means comparing marginal, not average costs and benefits |
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Absolute Advantage
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one person takes fewer hours to perform a task than someone else
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Market/Capitalist Economy
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decisions made by individual households and firms who participate in markets
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Central Economy
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decisions made by # individuals on behalf of a group
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Demand
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how much people are willing to and able to buy
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Supply
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how much product is supplied at different prices
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Equilibrium
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where the supply and demand intersect, no frustrated buyers or sellers
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Equilibrium Price
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MB=MC
and consumers are getting much of the commodity as they value the use of those resources to produce those good |
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Exogenous variable
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the value of this variable is given
(not determined by the operations of the model) |
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Endogenous Variable
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the value of this variable is determined by the operations models
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Changes in Exogenous variable cause change in Endogenous variable but...
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changes in endogenous variable do not chang exogenous variable
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Aggregate Output
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measure by GDP
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Market Value
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goods and services are counted at their price quantity (PQ) This allows us to make comparisons about aggregate production
only goods and services exchanged in markets are included as GDP --therefore, unpaid work not included |
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4 Macro Sectors
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1. Households
2. Firms 3. Government 4. Foreign |
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GDP Production Method
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count the value of the final goods and service indirectly by dding up the vale added by each firm in the production process
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GNI
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Gross National Income
----------- measures the income earned by all citizens of a country irrespective of where those citizens live |
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GDP Expenditure Method
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all current production by firms must be bought by someone- by households, other firms, government or foreigners- or is unsold
production not sold is added to inventories and treated as spending or bought by the firm - GDP can also be measured as the sum of spending on domestic production by households, all firms, govt, and foreigners GDP= Y = C+I+G+X-M |
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C
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Household Consumption Spending
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I
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Firm Spending is Investment
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G
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government spending
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X
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foreign spending on our exports
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M
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import spending
-- doesn't include transfer pymts- reallocation -- doesn't include second-hand goods |
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GDP Income Method
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when a good or service is sold, the revenues from the scale are distributed to the workers and the owner sof the capital involved in production
- GDP also equal labour income plus capital income from production - labour is wages, salaries and self employed income, capital includes payments to physical capital, intangible capital and profits |
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GDPexpenditure=
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C+I+G+NX
=Lincome + Kincome |
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Nominal GDP
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current production at current prices
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Real GDP
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value of production changing
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Nominal GDP equation
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P^2010 * P^2010
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If Constant prices= 2005 prices
real GDP2010= |
P2005 * P2010
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Economic Growth Equation
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real GDP2010 - real GDP2009
________________________X100 real GDP2009 |
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Why is Real GDP not the same as wellbeing?
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GDP does not include:
-- leisure time -- unpaid services provided -- environmental quality -- resource depletion -- quality of life -- poverty and economic inequity |
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CPI
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Consumer Price Index
_____ basic tool measures the cost in that period of a standard basket of household essentials |
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CPI=
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cost of basket of good in current year
________________________ cost of basket of goods in base year |
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How do you use CPI to calculate the rate of Inflation?
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CPI(dec06)-CPI(dec05)
___________________ x100 CPI(dec05) |
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CPI overstates actual level of inflation because...
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1- quality adjustment bias because improvement over time in goods and services are dificult tand hard to adjust for
2- situation bias |
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Demand Curve
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Price Rising causes Quantity demanded to fall
- negative relationship between Price and Quantity |
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Supply Curve
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Price rising cause Quantity Supplied to Rise
-positive relationship between Price and Quantity |
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Surplus
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when more is supplied than demanded
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Scarcity
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when more is demanded than supplied
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Substitute
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when one good can be replaced for another good
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Compliment
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when two goods are used together
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Inflation
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rate of change of average price levels
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Shoe Leather costs
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associated with holding less cash on hand and more in the banks so as to offset the reduction of purchasing power with interest
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Noise in the Price Systems
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increasing prices should signal increased demand, but a high inflation environment interfers with the signal
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Distortion of the Tax System
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higher effective tax rates caused by 'bracket creep' in a progressive, non-indexed tax system
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Unexpected Redistribution of Wealth
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ratheer than destroys purchasing power an adverse effect on the economy if wealthy becomes a matter of inflation 'luck' rather than earned through incentives of productive work
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Interference with LR planning
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LR business and personal descisions become more difficult to make with high and erratic inflation and people dont want to invest when can't forecast future returns
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Menu Costs
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Uncertainty and cost is cuaused by frequent changes in price lists
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Deflation good?
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a sustained fall in the average price level can lead to high real interest rates and high real interest rates which discourages important expenditure types such as firm's investment in plant and equipment
- this is due to the fact thtat the nomial interest rate must be above 0% or loans would not be made |
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Real Interest Rate =
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nominal interest rate- interest rate
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National savings when NX=0 is
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GDP= Y = C+I+G+NX
if NX=0 we have a closed economy and Y= C+I+G |
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national Savings Equation
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difficulty in seperating spending on current needs in C and G has led to government stats
S= Y-C-G |
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Private Savings
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Y-T-C
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Public Savings
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T-G
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Government Budget Surplus
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when govt collections through tazation were greater than spending
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Government Budget Deficit
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spending exceeds taxation, become borrowers
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The Demand for Savings
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value of domestic investment that can be feasibly taken at each level of the Interest Rate
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The Labour Market
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Demand for labour is from employers for use in production of goods and services, supply of labour by people who work for pay
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VMP
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Value of Marginal Product of labour
------ change is total output ___________________ xpotential output change in Labour +1 which equals Change in TR ____________ Change in L +1 |
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MP of Labour=
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change in total output
__________________ chang in L +1 |
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The principle of diminishing marginal Return
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marginal product declines as more workers are added
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A firm will hire to point where
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W(nominal wage)= VMP= MPL x Potential Output
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Employed
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those who worked 1 hour or more in paid employment, or on leave
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Umpemployed
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did not work in paid employment and actively sough work
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Out of Labour Force
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did not work in paid employment and are not actively seeking employment
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Unemployment Rate=
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# of unemployed
______________ # in labour force |
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Participation Rate=
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labour force
__________ civilian pop. >15 yrs |
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Labour Force =
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employed +unemployed
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Economic Costs of Unemployment
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main costs is output lost due to labour force underutilisation, plu reduced tax collections and increased welfare spending
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Psychological costs
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loss of self-esteem, depression
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Social Costs
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increse in crime, domestic violence, etc
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Cyclical Unemployment
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varies with the 'business cycle' or state of the economy
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Natural Rate of unemployment
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exists independently of whether the economy is in an expansion or contraction= frictional + structural unemployment
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Structural Unemployment
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mismatch of skills demanded, minimum wage laws and other govt regulation, high unemployment benefits which rais the OC of working, workplace prejudice
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Economic Fluctuations
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are both irregular in length and severity
- impacts are generally felt throughout the economy, unemployment increases, durable goods are more effected than non-durable goods, inflation also fluctuates |
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The output gap
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if economic fluctuations are usual and require policy responce, measures how far actual output is from normal level
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Potential Output: Y*
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amount of hours of output the economy is capable of producing when using resources at normal rate
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Actual Output
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includes overtime, therefore can exceed or be less than Y*
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underutilisation
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Y-Y* Actual Output- Potential Output= negative
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overutilisation
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Y-Y* Actual Output- Potential Output= positive
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Okun's Law
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measures how much output is foregone with cylical unemployment, helps govt determine size of output gap
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AE= Aggregate Expenditure=
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C+I+G+NX=Y
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PAE
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Planned Aggregate Expenditure
PAE= C+Ip+G+NX |
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Consumption Spending Equation
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C+ c[Y-T]= C |
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C |
exogenous component of spending- independednt of dispoable income
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marginal propensity to consume
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the amount that consumption increases when disposable income increases
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Equilibrium Output
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level of output that does not tend to expand or contract
-occurs where firms produce Ip=I and Unplanned Inventory =0 |
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Contraction
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the economy is operating below the expected productivity, we are experiencing a fall in GDP
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Expansion
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the economy is operating above the expected productivity, we are experiencing a rise in GDP
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Peak
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the highest point in a period of time
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Trough
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the lowest poin tin a period of time
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Balanced Budget Multiplier
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+ΔG= +ΔT
ΔG--> ΔPAE= -c x ΔT= -cΔT= -cΔG recall ΔT=ΔG Combine ΔG+ ΔT--> ΔPAE= ΔG+(-cΔG) = ΔG(1-c) we know o<c<1 therefore ΔG(1-c)>0 $Y^ |
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3 Qualifiers to Using Fiscal Policy as Stabilisation Tool
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1. Fiscal policy and supply side
2. the problem of deficits 3. fiscal policy is relatively inflexible |
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Fiscal Policy and Supply side
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affects potential output as PAE
G on public spending playing major role in the growth of potential GDP |
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Problem of Deficits
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Expansionary fiscal policy leads to deficits and govt needs to avoid large, persistent ones
^ G on infrastructure--> ^PAE and ^ K --> ^Y deficits reduce national savings and investment |
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FP is relatively inflexible
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fiscal policy would need to act swiftly to addres output gaps as they arise
however, changing govt spending or taxes must go through a lengthy legislative process, which makes it difficult for FP to be used as a timely response |
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Distribution of Income
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influence the total disposable income progressive taxes
-- increased income has increased taxes income inequality has increased over the years due to growing desire for skilled workers |
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Managing Demographic Change
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looking at change in birth and death rate effects spending o health and pension and aged care
Tax Revenues are difficult to forecast, assumed will stay the same for GDP |
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Fiscal Policy and Public Debt
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1. can increase T
2. can borrow money 3. can print money |
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Benefits of Public Debt
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when important infrastructure projects are financed through public debt
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medium of exchange with money
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avoids barter and promotes specialisation
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Unit of Account
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the basic yardstick for measuring economic value
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Store of Value
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a way of holding wealth
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Currency
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notes and coins on issue, less holding by banks
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M1
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currency plus current deposits held by banks
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M3
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M1+ all bank deposits of the private non-bank sector
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Broad Money
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M3+ borrowing from the private sector by non bank depository corporations, less holdings of currency and deposits of non-bank depository corporations
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Money Supply
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consists of currency and bank deposits
therefore: amoun of money also depends on the behavior of commercial banks and their depositers |
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Fractional Reserve:
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only a small part of the depostis are withdrawn at anytime, only need to keep a fraction for transactions and the rest can be loaned
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Open Market Operations
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OMO
____ the buying and selling of govt financial assets such as short term bonds |
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Exchange settlement accounts
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accounts the commercial bank holds to have help managing the flow of funds from transactions btw them
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Demand for Money
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total amount of wealth households want to hold in form of currency
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PAE in 4 sector model
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C+Ip+G+X-M
_ _ C-cT+ c(1-t)Y+Ip+G+X-m(1-t)Y C+Ip+G+X-cT+ (c-m)(1-t)Y |
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PAE will undergo an upward parallel shift if ther is an--
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^ in either C or Ip or G or X
decrease in T |
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PAE will undergo a downward parallel shif if there is a--
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decrease in C or Ip or G or X
increase in T |
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Portfolio allocation decisions
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household decisions about the mix of real and financial assets they hold their wealth in
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Demand for Money
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need to hold money for transactions with suppliers and customers
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Factors that change the amount of money people want to hold at any given nominal interest
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1. real income or output; as income increases, more money is required for higher level of transactions
2. Price Level(P): increase price level , the more dollars needed to finance the same volume of transactions |
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Supply of Money
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influend by the RBA and consists of notes and coins in circulation plus deposits in the banking system
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Equilibrium Interest Rate
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where supply meets demand
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Reserve bank wants to control the money in circulation, what policies can be used?
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open market operations
reduce lending to banks increase legal reserve |
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Aggregate Demand
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shows the relationship between Short Run equilibrium output and the rate of inflation
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Why does AD slope down?
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based on the RBA's policy reaction function
AD curve is downward sloping when interest rate is on the y-axis and x-axis is output 1. high inflation reduced the purchasing power of financial assets and this reduction of real wealth at high inflation reduces spending therefore as increase in interest rate, decrease value of inet assets and decrease Consumption 2. Distributional effects: high inflation tends to redistribute resources fro less well off households who spend a lesser proportion therefor increase of interest rate decreases consumption 3. higher inflations generates uncertainty for households and firms and this makes themmore caution and reduces spending therefore high interest rate increases uncertainty and decreases C and I 4. At constant exchange rates, as domestic interest rate rises relative to interest rate overseas, domestic goods and services become relatively more expensive compared to foreign produced goods and services. This leads economic agents to switch their expenditure so that e |
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Shift in AD due to
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1) Exogenous change in spending
---- increase in G Ip C or X leads to an increase in PAE and a upward shift. PAE shifts up ---> AD shift right 2. Exogenous Changes in RBA's Policy Reaction Function ---- the RBA usually follows a stable rn fxn, will change real interst rate at each inflation levle --- if RBA changes how they react to a given level of inflation, they would set a different real interest rate at same level of inflation as previously ---- this shift in the policy would cause AD to shift as a different equilibrium output which would result at each inflation rate |
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Inflation Inertia
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due to wage and price contracts: wages and the prices of many inputs are usually negotiated for a period of time Nominal prices negotiated include the expectation of inflation and these are usually based on the recent inflationexperience
by anticipating the increase and plannign for it, we increase the likelihood that it will happen |
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Traded weight Index
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value of the dollar expressed as an average of its values against values of other currencies
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Flexible Exchange Rate
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exchange rate varies according to the S and D for currency
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Fixed Exchange Rate
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currency not allowed to cary with market conditions, value are set by govt policy
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Real Exchange Rate
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compares prices of average dometic good relative to average foreign good
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When Real Exchange Rate is High
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domestic goods more expensive than foreing goods
NX increases |
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When REA is Low
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domestic goods less expensive than foreign goods
NX decreases |
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Purchasing Power Party
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that nominal exchange rates are determined as necessary for law of one price to hold
- predicts that currency of a country that experiences significant inflation will depreciate - useful to predict changes n nominal rates over long run but les well in SR - relies on lwa of one price |
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SR PPP
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Demand for $A is from foreigners who seek to purchase Australian goods
Supply for $A is by Aussies who seek to purchase foreign goods |
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Supply's upward Slope
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as exchange rate increases, cheaper are foreign goods to buy using $A
there for more purchases made by Aussies and more $A are supplied |
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Demand's downward slope
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demanders of $A in foreign exchange market are foreign homes so they can buy Aussie goods.
lower exchange rate, cheaper are AUS goods to buy using foreign currency therefore more purchasing by foreigners and more $A demanded |
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Changes in Interest rate on AUS Assets
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D shift only
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Changes in interest rate of foreign assets
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S shift only
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Monetary Policy
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tightening-- Increased interest rate-- increased attraction to OZ assets
--shift D-- increase e and increases Q $A supplied |
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closed economy monetary policy
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tightening decreases AD through decreased C and I
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Open economy with flexible Exchange Rate
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tightening will increase e, decrease X increase M
-- NX decrease AD further and reinforces monetary policy --- Decrease NX--> decrease Y |
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Fundamental Value < Official Value
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overvalued 'e'
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Fundamental Value > Official Value
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undervalued 'e'
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Balance of Payments
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BoP
a record of all the transactions made between the resident of one country with residents of all other countries |
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Capital Account
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records all international transactions
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Capital Flows
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purchase and sales of real and financial assets across international borders
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capital inflows
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purchase of domestic assets by foreigners
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capital outflows
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purchase of foreign assets by domestic households or firms
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Determinants of Capital Flow
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attractiveness of any asset are return and risk
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