Unit VII

Unit 7 

Balance of Payments

Measures of money inflows and outflows between the U.S. and the rest of the world

• Inflow = credit
• Outflow = debit

Divided into 3 accounts

• Current Account
• Capital/Financial Account
• Official/Reserve Account

Double Entry Bookkeeping

 

Every transaction in the balance of payments is recorded twice with standard accounting practice

Current Account 

•  Balance of trade/Net exports

• Exports of goods/services - import of goods/services
• Exports = credit
• Import = debit

•  Net Foreign Income

• Income earned by U.S. owned foreign assets - income paid to foreign held U.S. assets

• Net Transfers

• Foreign aid  - debit to the current account

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

 Direct investment by U.S. firms/individuals in a foreign country are debits to the capital account

 Purchase of foreign financial assets represents a debit to the capital account

 Purchase of domestic financial assets by foreigner represents a credit

 What causes these flows?

• Differences in rates of return on investment
• Ceteris Paribus, savings will flow toward higher returns
  

Relationship between Capital and Current Account

Double entry bookkeeping

Zero each other out

Official Reserves

• Foreign currency holding of the U.S. Fed

• When there is a balance of payments surplus the Fed accumulates foreign currency and debits the balance of payments

• When there is a balance of payments deficit there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments

Credit vs. Debit

·                     Credit - addition to a nation's account

·                     Debit - subtractions to a nation's account

How to Calculate

1.             Balance on trade

• Merchandise and service exports - merchandise and service imports

2.             Trade deficit occurs when the balance on trade is negative

• imports > exports

3.             Trade surplus when bot is positive

• exports > imports

4.             Balance on current account

• Balance on trade + net investment income + transfer payments

5.             Official Reserves

• Nationally change in CA + change in FA + change in official reserves = non zero

Foreign Exchange (FOREX)

Buying and selling of currency

The exchange rate is determined in the foreign currency markets

Exchange rate is price of currency

Changes in Exchange Rates

• Exchange rates are a function of the supply and demand for currency

• An increase in the supply of a currency will decrease the exchange rate of a currency
• Decrease in supply of currency will increase exchange rate
• Increase in demand for currency, increase in e
• Decrease in demand for currency, decrease in e

Appreciation and Depreciation

Appreciation - when e of currency increases

Depreciation - when e of currency decreases

Exchange Rate Determinants

• Consumer's Taste

• Relative Income

• Relative Price level

• Speculation

• Flexible Exchange Rate

• Set by market forces with little or no government intervention

• Fixed Exchange Rate

•  Determined by government policies

Absolute Advantage - Faster, more efficient

Comparative Advantage - Lower opportunity cost

• Same country can have absolute advantage in 2 products

• Can only have one comparative advantage in 1

UNIT IV

UNIT IV

Uses of Money:

• Medium of exchange - where one is able to buy goods and services
• Unit of account - establishes economic work
• Store of value - money holds its value over a period of time

- Types of money:

• Commodity money - swapping goods
• Representative money - I.O.U.s
• Fiat money - a government-established money 

- Characteristics of money:

1. Durability
2. Portability
3. Divisibility - can be divided down
4. Uniformity - same throughout the nation
5. Scarcity
6. Acceptibility

 - Money Supply:

• M1 money:
• consists of currency in circulation
• check-able deposits (demand deposits)
• traveler's checks
• M2 money:
• consists of M1 money + savings accounts + money marker accounts + deposits held by banks outside the U.S.

- Fractional Reserve Banking - process by banks of holding a small portion of their deposits in reserve + loaning out the excess

- Significance of a Fractional Reserve System

1. Banks can create money by lending more than their reserve
2. Required reserves doesn't prevent bank panics because banks must keep required reserves
3. Reserve requirement gives federal government control of how much money banks can create

- Functions of the FED

1. Control the nation's money supply through monetary policy
2. Issue paper currency
3. Serve as a clearing house for checks
4. regulate banking activity
5. serve as a bank for banks

- Balance sheet:

•  Is a statement of assets and claims summarizing the financial position of a firm or bank during a certain point in time
• MUST BE BALANCED AT ALL TIMES
• Assets - what you own
• Liabilities - What you owe

Multiple Deposit Expansion:


- Assets:

• Reserves
• required reserves - % required by the Federal Government to keep on hand to meet demand
• excess reserves - % of reserves over and above the amount needed to satistfy the minimum reserve ratio
• loans to firms, consumers and other banks
• loans to the government
• bank property - if bank fails, buildings can be liquidated

- Liabilities:

• Demand deposits - $$ put into an account
• timed deposits
• loans from - Fed reserves and other banks
• Shareholders Equity - to set up a bank, you must invest your own money in it

- Reserve requirement:

• The Fed. requires banks to always have some money readily available
• The amount set b the Fed is the required reserve ratio
• Required reserve ratio is the % of demand deposits that must nit be loaned out
• Typical required reserve ratio is 10%

Required Reserve Ratio:

- It is the amount of demand deposits that must be stored as vault cash or as Federal funds in the bank's account with the Federal Reserve

- The required reserve ratio determines the money multiplier (1 / required reserve ratio)

•  Decreasing the reserve ratio increases the rate in which money is created = expansionary
•  Increasing the reserve ratio decreases the rate in which money is created = contractionary

- Changing the required reserve ratio is the least used method for monetary policy

- Money multiplier:

• Shows the impact of a change in demand on loans and eventually the money supply
• Indicates the total number of dollars created into the banking by each $1 addition to the monetary bank

Fiscal and Monetary Policy:

- Congress controls fiscal policy - can either tax or spend
- FED controls monetary policy - open-market operation

• Required reserve - money needed to keep in vault or reserves
• Discount rate - interest rate charged by the FED for overnight loans to commercial banks
• Federal Fund Rate - interest rate charged by one commercial bank for overnight loans to another bank

Loanable Funds Market:

- Market where savers and borrowers exchange funds (Qlf) at the real interest rate (r%)

- The demand for loanable funds, or borrowing comes from households, firms, government and the foreign sector.

- Supply of loanable funds or savings comes from households. Supply of loanable funds is also the demand for bonds

- Change in the demand for loanable funds:

• More borrowing = more demand for loanable funds = shift to the right
• Less borrowing = less demand for loanable funds = shift to the left

- Change in the supply of loanable funds

• More saving = more supply of loanable funds = shift to the right
• Less saving = less supply of loanable funds = shift to the left 

UNIT III

UNIT III

Aggregate Demand:

- Aggregate demand - shows the amount od real GDP that the private, public and foreign sector collectively desire to purchase at each possible price level.

      - the relationship between the price level and the level of real GDP is inverse

- 3 reasons AD is downward sloping

• Real Balance 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 in turn encourages investment
• Foreign Purchase 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 AD

• Changes in consumer, investment, and government spending and net exports
• a multiplier effect that produces a greater change than the original change in the 4 components
• increase in AD is a rightward shift; decrease would be a leftward shift
• Change in government spending & net exports
• increase = AD shift rightward, increased GDPr and price level, decrease in unemployment, and increase in interest rate
• decrease = AD shift leftward, GDPr and price level goes down, increase in unemployment and decrease interest rate

- Ranges/shapes/views of Aggregate supply

• Keynesian range: horizontal AS curve; below full employment; AD shift outward; increase in GDPr and a decrease in unemployment
• Intermediate range: AS shift outward, GDPr and Price level increases.
• Classical range - the long run AS curve; is vertical

 Aggregate Supply:

- The level of GDPr that firms will produce at each price level
-  Long-run

• period of time where input prices are completely flexible and adjust to changes in the price level
•   level of GDPr supplied is independent of the price level

- Short-run

• period of time where input prices are sticky and do not adjust to changes in price level
• directly related to price level

- Long-run Aggregate Supply (LRAS) - marks the level of full employment in the economy
     - measures potential output

• Causes for LRAS
• Increase in capital
• Change in technology
• Economic growth
• Entrepreneurship
• Increase in available resources

- Short-run Aggregate Supply (SRAS) - sticky wages = low profit = low production
     - increase in SRAS = rightward shift
     - decrease in SRAS = leftward shift
- Unit production cost = Total input cost / total output
- Determinants

• Input Prices
• Increase in resource prices is a leftward shift in AS
• Decrease in resource prices is a rightward shift in AS
• Productivity - total output / total input
• higher production = lower per unit production cost
• lower production = higher per unit production cost
• Legal Institution (environment)

- Full employment equilibrium = AD, SRAS, LRAS intersect
- Recessionary gap - equilibrium is below full employment (LRAS is to the right of intersection)

- Inflationary gap - equilibrium is beyond full employment (LRAS is to the left of intersection)


Multiplier

- Disposable income - income after taxes or net income

• With disposable income, households can either consume or save

- Consumption

• household spending
• ability to consume is constrained by:
• amount of disposable income
• propensity to save
• Do households consume if DI = 0?
• autonomous consumption
• dissaving

- Saving

• household not spending
• ability to save is constrained by
• amount of disposable income
• propensity to consume
• DI = 0; no saving

- Average propensity to consume (APC) and Average propensity to save (APS)

• APC + APS = 1
• 1 - APC = APS; vice versa
• APC > 1 = dissaving
• -APS = dissaving

- Marginal propensity to consume and save (MPC and MPS)

• MPC 
• change in consumption / change in disposable income
• % of every extra dollar earned that is spent
• MPS
• change in saving / change in disposable income
• % of dollar earned that is saved
• MPC + MPS = 1
• 1 - MPC = MPS; vice versa

- Determinants of consumption and saving

•  wealth
• expectation
• household debt
• taxes

The Spending Multiplier Effect

- an initial change in spending causes a larger change in aggregate spending or AD

• multiplier = change in AD / change in spending 

- Why it happens - expenditures and income flow continuously which sets off a spending increase in the economy
- spending multiplier = ( 1 / ( 1 - MPC ) ) or 1 / MPS
     - positive = increase in spending; negative = decrease in spending
- tax multiplier = -MPC / MPS
     - it is negative because money is leaving circular flow
     - a tax cut would mean a positive change


Investment

- What is investment? 
     - money spent or expenditures on

• new factories
• capital equipment
• technology
• new homes
• inventories

- Expected rates or return

• How do businesses make investment decisions?
• through cost and benefit analysis
• How do businesses determine the benefits?
• through the expected rate of return 
• How do businesses count the cost?
• through the interest costs 
• How do businesses determine the amount of investment they undertake?
• compare expected rate of return to interest cost
• if expected return > interest cost, then invest, if not, then do not invest.

Real (r%) vs. Nominal (i%) interest rate
- difference - nominal os observable rate of interest. Real interest rate subtracts out inflation
- How do you compute the real IR?
     - real interest rate = nominal interest rate - interest rate
- Real interest rate determines investment decisions

Investment Demand Curve

- Downward sloping because

• when interest rates are high, fewer investments are profitable; when IR is low, more investment is profitable
• conversely, there are few investments that yield high rates of return

- Shifts in ID

• cost of production
• change in technology
• business taxes
• stock of capital
• expectations

Fiscal Policy

- Change in the expenditure/tax revenues of the federal government

• taxes - government can increase or decrease taxes
• spending - government can increase or decrease spending

- Fiscal policy is enacted to promote our nation's economic goals; full employment, price stability, and economic growth
- Deficits, surpluses and debt

• Balance budget: revenues = expenditures
• Budget deficit: revenues < expenditures
•  Budget surplus: revenue > expenditures
• Government debt - sum of all deficit - sum of all surpluses
• Government must borrow money ifit is in a budget deficit
• can borrow from individuals, corporations, financial institutions, and foreign entities/government   

- Fiscal policy - Discretionary (action) - expansionary (deficit)
                                                              - contractionary (surplus)
                        - Non-discretionary (no action)
- Discretionary vs. Automatic fiscal policy

• Automatic - no government intervent
• Discretionary - increase or decrease in government spending/taxing to bring economy back into full employment

- Contractionary vs. Expansionary fiscal policy

• Contractionary - policy designed to decrease aggreage demand
• strategy to control inflation
• inflation is countered by contrationary policy
• decrease in government spending and increase in taxes
• Expansionary - designed to increase AD
• recession is counter with expansionary policy
• increase in government spending and decrease in taxes

UNIT II

UNIT II

4 Types of economic system:

•  Command (centrally planned) 
• Government owns the factors of production
• Does not support or encourage new ideas and technology
• ex: Cuba
• Traditional
• Relies on habits, rituals, or customs
• Elders usually makes the decisions
• ex: tribes
• Free Market
• People in firms act in their own self-interest
• Allows for buyers and sellers to exchange goods and services
• ex: Hong Kong
• Mixed
• The government controls some aspect of business production
• ex: U.S. , Canada

The 3 economic questions:

1. What goods and services should be produced?
2. ow will the gods and services be produced?
3. For whom will the goods and services be produced? 

NOTES

- Market - an institution/mechanism allowing buyers and sellers to make and trade goods and services

• Product - buyer is usually a consumer and seller is a firm
• Factor - buyer is the firm and seller is factor owner (most important factor is labor)

- Households - a person or group of people that share their income
- Firms - an organization that produces goods and services for sale

- GDP  (Gross domestic product) - Total value of all final goods and services produced within a
                                                  country's borders within a given year

• GDP = Personal consumption + Gross private domestic investment + Gov. spending of goods and services + net exports | (net exports = exports - imports)
• refer as: C + Ig + G + Xn
• Includes - all production or income earned withing the U.S. by U.S. and foreign producers
• final goods and services | earned income | W.R.I.P. (wage, rent, interest, profit) | interest payments on corporate bonds | current production of goods and services | unsold output (inventory)
• Excludes - production outside of U.S. even by Americans
• used goods | gifts (private or public) and transfers (ex: Soc. Security) | stock | unreported business activity | illegal activity | financial transaction between banks and/or businesses | intermediate goods | non-market activity (ex: babysitting)
•  Expenditure Approach - income generated from production of goods and services
• equation = C + Ig + G + Xn 
• Income Approach - income generated from final goods and services
• equation =  W + R + I + P + statistical adjustments

- GNP (Gross national product) - Total value of all final goods and services produced by Americans
                                                in a given year

• Includes - production or income earned by Americans anywhere
• Excludes -  production by non-Americans even in the U.S.

- Deflation - decline in general price level
- Disinflation - interest rate itself declines
- Standard Inflation Rate = 2-3%
- Rule of 70 - how long it takes for inflation to double (in years) = 70 / annual inflation rate
- Real Interest Rate - Nominal interest rate - inflation
- Causes of inflation

• Demand Pull
• Caused by an excess of demand over output that pulls prices upward
• Sources: increase in government purchases | excessive increases in the money supply (hyperinflation) | rising income as economy approaches full employment
•  Cost Push
• Caused by a rise in per unit production cost due to increasing resource cost
• Sources:
• Supply Shock - dramatic increase in energy/raw material prices due to inpit shortages or growing input demand
• Price Wage Spiral - workers seek higher wages to offset rise in consumer prices

- Effects of inflation (Anticipated vs Unanticipated)

• Unanticipated inflation has stronger effects because those expecting inflation maybe able to adjust their work or spending activities
• wages and pensions have costs of living adjustments built in to offset anticipated inflation
• expected inflation increase the nominal cost of borrowing while unexpected inflation reduces the real cost of borrowing
• Those hurt are the ones who - lend, save up money, and those with fixed income
• Those who benefit are borrowers

- Unemployment - failure to use available resources
- Employed - includes those that are self-employed
- Unemployed - new entry to the job market OR

1. Re-entrant - re-entering the job market
2. Laid off - position has been down-sized
3. Fired
4. Quit

- Not in labor force - armed services, home makers, students, retirees, disabled, mental institution, in prison
- Unemployment rate: (# of unemployed / total labor force) * 100
             - standard rate of unemployment is between 4-6%

Types of Unemployment 

• Frictional - temporary, short-term, transition
• Ex: recent grduates looking for a job | people who quit/fired and looking for a better job 
• Signals new job openings..'
• Cyclical - caused by the recession stage of the business cycle due to a deficient demand for goods and services
• Job loss that will come back
• Structural - deals with technology and long-term change
• automation - results from job loss due to change in consumer taste
• creative destruction - as new jobs are created, others are lost 
• Seasonal - depends on weather/season
• Ex: Santa, Easter Bunny
• 
  

FORMULAS

- Net National Product (NNP) = GNP - depreciation

- Net Domestic Product (NDP) = GDP - depreciation

- National Income (NI) [ 3 equations ]

1. = NNP - Indirect Business Taxes (IBT)
2. = CE (wages) + Ri (rent) + Ii (interest income) + CP (corporate profits) + PI (proprietor's income)
3. = GDP - IBT - depreciation - Net foreign factor payment

- Disposable Person Income (DPI) = National Income - Household Tax + Government transfer payments (GTP)

- Trade = Export - Import

• Positive = Surplus | Negative = Deficit

- Budget = Government purchase of goods and services + GTP - Government tax and fee collection

• Positive = Deficit | Negative = Surplus

- Nominal GDP - measures GDP in current dollars, no matter the produced output

• = Price * Quantity

- Real GDP - measures GDP in constant dollar. Adjusted for inflation by holding the purchasing power of the dollar constant

• = Price * Quantity

- GDP Deflator - (Nominal GDP / Real GDP) *100
- Inflation - a rise in the general price level

• = [(Price index of year 2 - Price index of year 1) / Price index of year 1] * 100

- Consumer Price Index (CPI)

• (Price of market basket in a year / Price of same market basket in previous year) * 100

Supply (week of january 21st)

• Total Revenue - the total amount of money a firm receives from selling goods and services 
• Total revenue (TR) = Price x Quantity

•  Fixed cost - a cost that doesn't change no matter how much is produced
• ex: salary, mortgage 
• Variable cost - a cost that rises/falls depending upon how much is produced.
• ex: water, phone services, electricity
•  Marginal costs - cost of producing one additional unit of a good

• Marginal revenue - additional income from selling one more unit of a good 
•  Marginal revenue = New TR - Old TR

 Supply Chart:

Equations:

• Marginal Cost (MC) = New Total Cost (TC) - Old TC
• Average Fixed Cost (AFC) = Total Fixed Cost (TFC) / Quantity
• Average Variable Cost (AVC) = Total Variable Cost (TVC) / Quantity
• Average Total Cost (ATC) = TC / Quantity OR AFC - AVC

Board game project

DUE FEBRUARY 8

UNIT 1 intro

Microeconomics vs. Macroeconomics 

  

• Microeconomics - the study of how households and firms make decisions and how they interact in the market
• ex: supply and demand, market structure
• Macroeconomics - the study of major components of the economy
• ex: inflation. wage laws, international trade 

Positive economics - claims that attempts to describe the world as is

     ex: minimum wage laws causes unemployment

Normative economics - claims that attempt to prescribe how the world should be

     ex: the government should raise the minimum wage

Want - a desire

 Need - the basic requirements for survival

 Scarcity - the most fundamental economic problem facing all societies

     ~ how to satisfy unlimited wants with limited resources

Shortage - quantity demand > quantity supplied

Goods vs Services

• Goods - tangible commodities ( 2 types )
• capital - items used in the creation of other goods
• ex: machines, trucks
• consumer - goods that are intended for final use
• ex: burgers   

• Services - can't be touched or felt; work performed for someone

The 4 types of production

1. land - natural resources
2. labor - work exerted
3. capital
1. human - knowledge acquired skills
2. physical - machinery 
4.  entrepreneurship - risk taking

Production Possibility

 

Opportunity cost - the most desirable alternative

Guns or Butter tradeoff - things aren't produced at equal levels

 Production possibility graph - shows an alternative way to use resources

Increasing opportunity cost - the opportunity cost of producing an additional unit of a product increases as more of that product is produced

If the graph is concave (bowed out), then 4 assumptions can be made

1. fixed technology
2. fixed resources
3. full employment efficiency and productive efficiency
4. -

Productive efficiency - producing at the lowest cost
     ~efficiently allocate resources and full employment of resources

Allocative efficiency - combination of the most desired by society or those in charge of economic decisions