As curve doesn't shift in response to changes in the AD curve in the short run
I.E. - Nominal wages do not respond to price - level changes
Workers may not realize the impact of the changes or may be under contract
Long Run
Period in which nominal wages are fully responsive to previous changes in price level
- When changes occur in the short run, they result in either increased or decreased producer profits - not changes in wages paid.
- In the long run, increases in AD result in higher price level, as in the short run, but as workers demand mare $ the AS curve shifts left to equate production at the original output level, but not at a higher price.
- In the long run, the AS curve is vertical at the natural rate of unemployment (NRU), or full employment (FE) level of output. Everyone who wants a job has one and no one is enticed into or out of the market.
- Demand - pull inflation will result when an increase in demand shifts the AD curve to the right, temporarily increasing output while raising prices.
- Cost - push inflation results when an increase in input costs that shifts the AS curve to the left. In this case the price level increase is not in response to the increase in AD, but instead the cause of price level increasing.
Phillips Curve
Represents the relationship between unemployment and inflation
The trade off between inflation and unemployment only occurs in the short run
Given SRAS curve an increase in AD will cause price level and real output to increase which increases inflation and reduces unemployment
Each point on the Phillips curve corresponds to a different level of output
Long Run Phillips Curve (LRPC)
Occurs at the natural rate of unemployment
Represented by a vertical line
No trade off between inflation and unemployment in the long run
The economy produces at the full employment output level
Nominal wages of workers fully incorporate any changes in price level as wages adjust to inflation over the long run
LRPC will shift only if the LRAS curve shift
If the NRU changes the LRPC moves
NRU is equal to frictional, seasonal, and structural unemployment
Short Run Phillips Curve (SRPC)
Assumed to be stable because short run AS curve is stable
If inflation persist and the expected rate of inflation rises then the entire SRPC moves upward.
If move upward, cause of stag flation
If inflation expectation drop due to new technologies or then the SRPC moves downward
Supply Shocks
Rapid and significant increase in resource cost which causes SRAS to shift thus producing a corresponding shift in the SRPC
Misery Index
Combination of inflation and unemployment in any given year
Single digit misery is good
Stagflation
Have high employment and inflation at the same time
Disinflation
Inflation decreases overtime
Supply-Side Economics or Reaganomics
Support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments (unemployment compensation & social security) provide disincitives to work invest innovate and undertake entrepreneur ventures.
Lower tax rate induces more work thus AS decrease.
The lower the marginal tax rate make leisure work more expensive
Laffer Curve
Relationship between tax rates and government revenue
The higher the tax rate you set, the less money you will collect
Laffer curve is controversial and debatable
As tax rates increase from 0, tax revenues increase from zero to some maximum level.
3 criticisms
Where the economy is actually located on the curve is difficult to determine
Tax cuts increase demand which can fool inflation
Empirical evidence suggest that the impact of tax rates on incintives was to work saving and invest are small
Trickle-Down Effect
Call for lower taxes for the rich and less regulation to stimulate the economy
Balance of Payments
Measure of money inflows and outflows between the U.S. and the rest of the world (ROW)
Inflows are referred to as CREDITS
Outflows are referred to as DEBITS
Balance of payments is divided into 3 accounts:
Current account
Capital/financial account
Official reserves account
Current Account
Balance of Trade or Net Exports
Exports of good/services - imports of goods/services
Exports create a credit to the balance of payments
Imports create a debit to the balance of payments
Net Foreign Income
Income earned by U.S. owned foreign assets - income paid to foreign held U.S assets.
Ex.) Brazilian bonds - interest payments on German owned U.S. treasury bonds
Net Transfers (Tend to be Unilateral)
Foreign aid --> a debit to the current account
Ex.) Mexican migrant worker sends money to family in Mexico
Capital/Financial Account
Balance of capital ownership
Includes the purchase of both real and financial assets
Direct investment in the U.S is a credit to the capital account
Ex.) Toyota factory in San Antonio
Direct investment by U.S. firms/individuals in a foreign country are debits to the capital account
Ex.) The Intel Factory in San Jose, Costa Rice
Purchase of foreign financial assets reps a debit to the capital account
Ex.) Warren Buffet buys stock in Petrochina
Purchase of domestic financial assets by foreigners represents a credit to the capital account
United Arab Emirates Sovereign wealth, fund purchase a large stake in the NASDAQ
Relationship between Current and Capital Account
Current account and the capital account should zero each other out, that is... if the current account has a negative balance (deficit), than capital account should then have a positive balance (surplus)
Official Reserves
Foreign currency holdings of the U.S. states federal reserve system
When there is a balance of payments, surplus the Fed accumulates foreign currency and debits for balancing of payment
When there is a balance of payments, deficit the Fed deputes its reserves of foreign currency and credits the balance of payment
The official reserves zero out for balance of payments
Double Entry Bookkeeping
Every transaction in the balance of payments is recorded twice in accordance with standard accounting practice.
a.) Medium of exchange (bartering/trading) : able to buy goods and services
b.) Unit of account : establishes economic worth
c.) Store of value : money holds its value over a period of time
II. Types of Money
a.) commodity money - swapping cake
b.) representative money - I.O.U
c.) fiat money - money because government says
III. Characteristics of Money
a.) durability
b.) portability
c.) divisibility
d.) uniformity
e.) scarcity
f.) acceptability
IV. Money Supply
a.) M1 money - consists of currency in circulation, checkable deposits (demand deposits), travelers checks
b.) M2 money - consists of M1 money, savings account, money market accounts, deposits held by banks outside U.S
Fractional Reserve Banking
process by banks of holding a small portion of their deposits in reserve and loaning out the excess
Required Reserve Ratio
% of demand deposit required by Fed to be kept in vault by banks
determined money multiplier (1/reserve ratio)
decreasing ratio increases rate of money creation in banking system: expansionary
increasing ratio decreases rate of creation : contractionary
10% = reserve ratio
Money Multiplier
shows impact of change in demand deposit on loans
money multiplier indicates total number of dollars created in banking system by each $1 addition to the monetary base (bank reserves and currency in circulation)
money multiplier = 1/required ratios
Three Types of Multiple Deposit Expansion Question
Type 1: calculate initial change in excess reserve ; (aka) amount a single bank can loan from initial deposit
Type 2 : calculate the change in loans in banking system
Type 3 : Calculate change in money supply ; sometimes type 2 & 3 will have the same result
Type 4: Calculate change in demand deposit
Required Reserve
= amount of deposit * required reserve ratio
Excess Reserve
= total reserves - required reserves
Maximum Amount a Single Bank can Loan
the change in excess reserves caused by a deposit
Total Change in Loans
= amount single bank can lead * money multiplier
Total Change in $ Supply
= total change in loans $ amount of Fed action
Total Change in Demand Deposits
= total change in loans + any cash deposited
Prime Rate
The interest rate bank charges to their credit worthy customers
Fiscal Policy VS. Monetary Policy
Fiscal Policy [Congress]
Tax or
Spend
Monetary Policy [FED]
Open market operation - OMO: buy or sell bonds
Reserve Requirement: bank's mass requirement
Discount Rate: interest rate charged by the Fed for overnight loans to commercial banks
Federal Fund Rate: interest rate charged one commercial bank for overnight loans to another commercial bank.
The Fed has several tools to manage the money supply by manipulation the excess reserves held by banks, a practice known as monetary policy
Loan-able Funds Market
Market where savers and borrowers exchange funds (Qlf) at the real rate of interest (r%)
The demand for loan-able funds, or borrowing comes from households, firms, government and the foreign sector. The demand for loan-able funds is in fact the supply of bonds.
The supply of loan-able funds, or savings comes from households, firms, government, and the foreign sector. The supply of loan-able funds is also the demand for bonds.
Changes in the Demand For Loan-able Funds
Remember that demand for loan-able funds = borrowing (i.e. supply bonds)
More borrowing = more demand for loan-able funds (--->)
Ex.)
Government deficit spending = more borrowing = more demand for loan-able funds .: Dlf --> .: r% increases
- Less investment demand = less borrowing = less demand for loan-able funds .: Dlf <-- .: r% decreases
Changes in the Supply of Loan-able Funds
Remember that supply of loan-able funds = saving (i.e. demand for bonds)
More saving = more supply of loan-able funds (-->)
Less saving = less supply of loan-able funds (<--)
Ex.)
Government budget surplus = more saving = more supply of loan-able funds .: Slf --> .: r% decreases
- Decrease in consumers MPS = less saving = less supply of loanable funds .: Slf <-- .: r% increases.
Shows the amount in Real GDP that the private, public and foreign sector
collectively desire to purchase at each possible price level
Relationship between price level and the level of Real GDP is inverse
3 Reasons why AD is Downward Sloping
- Real-Balances Effect
When the price-level is high, households and businesses cannot afford to
purchase as much output
When the price-level is low, households and businesses can afford to
purchase more output
- Interest Rate Effect
A higher price-level increases the interest rate which tends to discourage
investment
A lower price-level decreases the interest rate which tends to encourage
investment
- Foreign Purchases Effect
A higher price-level increases the demand for relatively cheaper imports
A lower price-level increases the foreign demand for relatively cheaper U.S.
exports
Shifts in Aggregate Demand (AD)
There are 2 parts to a shift in AD
A change in C , Ig , G , and/or Xn
A multiplier effect that produces a greater change than the original change
in the 4 components
Increases in AD = AD goes Right
Decreases in AD = AD goes Left
Aggregate Supply (AS)
Level of Real GDP that firms will produce at each price-level (PL)
Long Run Vs. Short Run
- Long Run
Period of time where input prices are
completely flexible and adjust to changes in the price-level
In the long-run, the level of Real GDP supplied is independent of the
price-level
- Short Run
Period of time where input prices are sticky and do not adjust to changes in
the price-level
In the short run, the level of real GDP supplied is directly related to the
price level
Long Run Aggregate Supply (LRAS)
LRAS marks the level of full employment in the economy (analogous to PPC)
ALWAYS VERTICLE
- What Causes LRAS to Shift
Increase in capital
Technology
Economic growth
Entrepreneurship
Resources available
Short Run Aggregate Supply (SRAS)
SRAS is upward sloping
- Changes in SRAS
Increase in SRAS is seen as a shift to the right. SRAS -->
Decrease in SRAS is seen as a shift to the left. SRAS <--
The key to understanding shifts in SRAS is per unit cost of production
Per-Unit Production Cost = total input cost / total output
- Determinants of SRAS
(All of the following affect unit production cost)
Input Prices
Increase in resource prices = SRAS <--
Decrease in resource prices = SRAS -->
Productivity
= total output / total inputs
more productivity = lower unit production cost = SRAS -->
lower productivity = higher unit production cost = SRAS <--
Legal - institutional environment
AD & AS VIDEO
What is Investment?
Money spent or expenditures on:
New plants (factories)
Capital equipment (machinery)
Technology (hardware & software)
New homes
Inventories (goods sold by producers)
Expected Rates of Return
- How does business make investment decisions?
Cost/benefit analysis
- How does business determine the benefits?
Expected rate of return
- How does business count the cost?
Interest costs
- How does business determine the amount of investment they
undertake
Compare expected rate of return to interest cost
If expected return > interest cost, then invest
If expected return < interest cost, then do not invest
Real (r%) vs. Nominal (i%)
- What's the difference?
Nominal is the observance rate of interest. Real subtracts out inflation
(pi%) and is only known ex post facto.
- How do you compute the real interest rate? (r%)
r% = i% - pi%
- What determines cost of an investment decision?
The real interest rate (r%)
Investment Demand Curve (ID)
- What is the shape of the investment demand curve?
Downward sloping
-
Why?
When interest rates are high, fewer
investments are profitable, when interest rates are low, more investments are
profitable
Conversely, there are few investments that
yield high rates of return, and many that yield low rates of return
Shifts in Investment Demand (ID)
Cost of production
Business taxes
Technological demand
Stock of capital
Expectations
Consumption and Savings
Disposable Income
Income after taxes or net income
2 Choices:
With disposable income, households can
either
Consume (spend money on goods and
services)
Save (not spend money on goods and
services)
Consumption
Household spending
The ability to consume is constrained
by
Amount to disposable income
Propensity to save
- Do households consume in (decreasing)DI = 0?
Autonomous consumption
Dissaving
Savings
Household not spending
Ability to save is constrained by
The amounts of disposable income
Propensity to consume
- Do households save if DI = 0?
NO
APC/APS
Avg propensity to consume
Avg propensity to save
APC + APS = 1
1 - APC = APS
1 - APS = APC
APC > 1 = dissavings
- APS = dissavings
MPS/MPS
Marginal propensity to consume
^C / ^ DI
% of every extra dollar earned that is spent
Marginal propensity to save
^S / ^ DI
% of every extra dollar earned that is saved
MPC + MPS = 1
1 - MPC = MPS
1 - MPS = MPC
Determinants of C & S
wealth
expectations
household debt
taxes
The Spending Multiplier Effect
An initial change in spending (C, Ig, G, Xn) causes a larger change in
aggregate spending, or aggregate demand (AD)
Multiplier = change in AD
/ change in spending
Multiplier = ^AD / ^ C,I,G, or X
- Why does this happen?
Expenditures and income flow continuously which sets off a spending increase
in the economy
Calculating the Spending Multiplier
The spending multiplier can be calculated from the MPC or the MPS
Multiplier = 1 / 1 - MPC [or] 1 / MPS
Multipliers are (+) when there is an increase in spending and (-) when there
is a decrease
Calculating the Tax Multiplier
When the government taxes, the multiplier works in reverse
- Why?
Because now money is leaving the circular flow
Tax Multiplier = -MPC / 1 - MPC [or] -MPC / MPS
If there is a tax- CUT, then the multiplier is (+), because there is now
more money in the circular flow
Fiscal Policy
Changes in the expenditures or tax revenues of the federal government
- 2 Tools of Fiscal Policy:
Taxes - government can increase or decrease taxes
Spending - government can increase or decrease spending
Deficits, Surpluses, and Debt
Balanced Budget
Revenues = Expenditures
Budget Deficit
Revenues < Expenditures
Budget Surplus
Revenues > Expenditures
Government Debt
Sum of all deficits - Sum of all surpluses
Government must borrow money when it runs a budget deficit
Government borrows from:
individuals
corporations
financial institutions
foreign entities or foreign government
Fiscal Policy Two Options
Discretionary Fiscal Policy (action)
Expansionary fiscal policy - think deficit
Contractionary fiscal policy - think surplus
Non - Discretionary Fiscal Policy (no action)
Discretionary vs. Automatic Fiscal Policy
- Discretionary
Increasing or decreasing government spending and/or taxes in order to return
the economy to full employment. Discretionary policy involves policy makers
doing fiscal policy in response to an economic problem
- Automatic
Unemployment compensation and marginal tax rates are examples of automatic
polices that help mitigate the effects of recession and inflation. Automatic
fiscal police takes place without policy makers having to respond to current
economic problems.
Contractionary vs. Expansionary Fiscal Policy
- Contractionary Fiscal Policy
Policy designed to decrease aggregate demand
Strategy for controlling inflation
- Expansionary Fiscal Policy
Policy designed to increase aggregate demand
Stategy for increasing GDP, combating a recession, and reducing
unemployment
Expansionary Fiscal Policy
Recession is countered with expansionary policy
Increase government spending
Decrease taxes
Contractionary Fiscal Policy
Inflation is countered with contractionary policy
Decrease government spending
Increase taxes
Progressive Tax Rate
Average tax rate (tax revenue/GDP) rises with GDP
Proportional Tax System
Average tax rate remains constant as GDP changes
Regressive Tax system
Average tax rate falls with GDP
The more progressive the tax system, the greater the economies built in
stability
Micro: it is the study of how households and firms make decisions and how they interact in the market
ex.) supply & demand ; market structures
Macro: it is the study of major components of the economy
ex.) inflation ; wage laws ; and international trade
Positive Economics VS. Normative Economics
Positive: claims that attempts to describe the world as is. Very descriptive in nature.
ex.) minimum wage laws causes unemployment
Normative: claims that attempt to prescribe how the world should be. It is very prescriptive in nature
ex.) government should raise the minimum wage
Wants VS. Needs
Want: is a desire Need: basic requirements for survival
Scarcity VS. Shortage
Scarcity: most fundamental economic problem facing all societies; how to satisfy unlimited wants with limited resources Shortage: quantity demanded is greater than quantity supplies
2 Types of Goods
Goods: tangible commodities - Capital Goods: items used in the creation of other goods
ex.) factory machinery ; trucks - Consumer Goods: goods that are intended for final use by the consumer
ex.) hamburger
What is a Service
Services: cannot be touched or felt ; work that is performed for someone
4 Factors of Production
Land: natural resources
Labor: work exerted
Capital: -Human: skills acquired or knowledge ; -Physical: machinery or equipment
Entrepreneurship: must involved risk taking
What is Opportunity Cost
Opportunity Cost: the most desirable alternative Increasing Opportunity Cost: the opportunity cost of producing an additional unit of a product increases as more of that product is produced
Graphs
Production Possibility Graph (PPG): to show alternative ways to use resources ; each point on the graph shows a trade off
- Production Possibility Curve (PPC)
- Production Possibility Frontier (PPF)
4 Assumptions can be Made
Have fixed resources
Fixed technology
Full employment and productive efficiency
Two products are being considered
Productive Efficiency and Allocated Efficiency
Productive Efficiency: producing at the lowest cost
have to allocate resources efficiency and have full employment of resources Allocated Efficiency: a combination of most desired by society or those in change of economic decision
PPC shifts to the Right
- Technological advancement
- New resources
- Trade (comparative advantage)
PPC Shifts to the Left
- Decrease in labor force (work skills, education levels)
- Permanent loss of productive capacity (taxes, war, government regulations)
3 Types of Movement
Inside the PPC: unemployment (deals with people) ; under employment of resources Outside the PPC: economic growth ; improve technology Along the PPC: ceteris paribus - all conditions remain the same
Demand and Supply
Demand: is the quantities that people are willing and able to buy at various prices The Law of Demand: there is an inverse relationship between price and quantity demanded Causes a "change in quantity demanded?": Δ in price Causes a "change in demand?":
Δ in the number of buyers (population)
Δ in buyers taste (advertising)
Δ in income (normal goods / inferior goods)
Δ in the price of related goods (substitute goods / complimentary goods)
Δ in expectations
Supply: is the quantities that producers or sellers are willing and able to produce/sell at various prices The Law of Supply: there is a direct relationship between price and quantity supplied What causes a "change in quantity supplied?": Δ in prices What causes a "change in supply?":
Δ in resource prices
Δ in technology
Δ in weather
Δ in taxes or subsidies
Δ in the number of supplies/sellers
Δ in expectation
Elasticity of Demand
A measure of how consumers react to change in price Elastic Demand: demand that is very sensitive to a change in price
E > 1
ex.) soda, steaks, coffee
Inelastic Demand: demand that is not very sensitive to a change in price; not mant suvstitutes
E < 1
ex.) gas, milk, sugar, salt, insulin
Unit Elastic or Unitary Elastic Demand:
E = 1
Equations
Total Revenue (TR): it is the total amount of money a firm receives from selling goods and services Fixed Costs: cost that does not change no matter how much is produced (salaris, mortgage, car note) Variable Costs: a cost that rises or falls depending upon how much is produced (electricity, water, etc.) Marginal Costs: is the cost of producing one additional unit of a good Marginal Revenue: the additional income from selling one more unit of a good
PED (Price Elasticity of Demand) = percentage change in quantity demand / percentage change in price
