Ten Principals of Economics (Chapter 1)
Resources are Scarce
- Scarcity: The limited nature of society’s resources (ex. Money, Water, Time, etc.)
- Economics: The study of how society manages its scarce resources.
- (MicroEconomics: the study of how households and firms make decisions and
how they interact in markets.
-Macroeconomics is the study of economy-wide phenomena, including inflation,
unemployment, and economic growth.
Economists study:
- How people decide
- How firms decide
- How society decides
How people make decisions:
- Principle 1: People face trade-offs. (To get something that we like, we have to give up
something else that we also like.)
Society faces trade-offs. (Guns or Butter?)
❖Efficiency or Equality? (both are considered when making effect9ve trade
offs)
❖Efficiency: society gets the maximum benefits from its scarce resources/how
productively we can produce goods and servicesw
❖Equality: Prosperity is distributed uniformly among society’s members.
(ex: Pollution regulations: cleaner environment
and improved health But at the cost of reducing the well-being of the firms’
owners, workers, and customers)
Sacrifice: To get Resource X, you have to sacrifice Y
-
- Principle 2: the cost of something is what you give up to get it
❖Making decisions:
- Compare costs with benefits of alternatives
- Need to include opportunity costs
❖Opportunities costs:
❖Whatever must be given up to obtain some item.
❖Value of next-best choice
Explicit Costs:
Marginal Cost:
Set Cost: Already in the past.
Marginal Benefit:
- Principle 3: Rational people think at the margin
❖Make decisions by evaluating the costs and benefits of marginal changes.
❖Marginal Changes: refers to small, incremental changes to the total quantity
of the variable. (small change/increase of something. (Small incremental
adjustments to a plan of action.)
❖Rational people make decisions by comparing costs and benefits. (Rational
people compare costs to marginal changes in an effort to evaluate the
benefits of an economic transaction.)
❖
Principle 4: People Respond to Incentives (Motivation or something that encourages to
do something )
- Rational Thinking? Consider the benefits
- Benefits, in this case, would be the incentive
- Different situations have different incentives. (Incentives could also be
negative, which can discourage certain actions within the economy. + & - )
How people interact
-Principle 5: Trade can make everyone better off
❖People can buy a greater variety of goods and services at a lower cost.
❖Benefits of Trade: allows us to receive resources that we would otherwise
struggle to get on our own
- Specialization: for resources, we have an abundance of, we can focus on
its production and trade.
• Countries benefit from trade:
❖– Allows countries to specialize in what they do best
❖– Enjoy a greater variety of goods and services
Principle 6: Markets are usually a good way to organze economic activity
-Market: A group of buyers and sellers (need not to be in a single location.)
-Organize economic activity” means determining:
What goods and services to produce (ex. Botched water, iphone, etc.)
How to produce these goods and services (how to get necessary resources)
How to allocate them to their final user (how do customers receive them)
What is the number one tool to organize the market? Price.
Prices:
- Determined by the interaction of buyers and sellers
- Reflect the good’s value to buyers
- Reflect the cost of producing the good
Principle 7: Governments can sometimes improve market outcomes
- Governments help to enforce rules and build/maintain institutions that can drive
economic growth.
- Government: Promote efficiency
-How do governments improve market outcomes? (promote efficiency and promote
equality)
- Avoid market failures: A market left on its own fails to allocate resources efficiently
- Government: Enforce property rights
- Enforce rules and maintain institutions that are key to a market economy.
- Government: promote equality
- Avoid disparities in economic well-being
- Use tax or welfare policies to change how the economic “pie” is divided.
Principle 8: a country’s standard of living depends on its ability to produce goods and
services
- The Standard of living is directly correlated to the production of goods and
services.
- Productivity: the number of goods and services produced per each unit of
labor;
- Quantity of goods and services produced from each unit of labor input
Principle 9: Prices rise when the government prints too much money (the dangers of
printing money)
-Inflation: An increase in the overall prices in the economy.
- Pumping more money into the economy drives down the value of that currency while
also boosting inflation.
- Hyperinflation: the rapid amount of inflation in a short period of time.
Principle 10: Society faces short-run trade-off between inflation and unemployment
- Short-run trade off between inflation and unemployment
- In the short run, many economic policies push inflation and unemployment in
opposite directions (as unemployment rises, inflation falls. As inflation rises
unemployment falls.)
Chapter 2
Economists play two roles:
-Scientists (try to explain the world)
-Policy Advisors (try to improve it)
- Positive Statements: Descriptive explanations to describe the state of things/how
things are. (Ex: prices rise when governments print more money– FACT)
- Normative Statements: Prescriptive explanations of how the state of things should
be.(Ex: Governments should print more money.)
Economists as a scientist
- Use models to study economic issues
- Simplified representation of a more complicated reality
The circular flow diagram: Model used by economists to explain the flow of money within
the economy. It includes parties and variables such as:
-Households: Own the factors of production, (sell/rent them to firms for income
- Buy and consume goods and services
- Firms: Buy/hire factors of production, and use them to produce goods and
services/ (Sell goods and services.)
- Market for Goods and Services: Where goods and services are bought and sold
- Market for factors of production: where inputs are bought and sold.
’
PPf: the graph that shows the combinations of inputs ad outputs that an economy can produce.
- Efficient: Points A-E: since they are on the PPF
- Innefficient: Points inside the PPF
- Infeasible: Points outside the PPf
Chapter 3: Interdependence and the Gains from Trade
Absolute Advantage: The ability to produce a good using fewer inputs than another
producer
- Producing one ton of soybeans
- 10 labor hours in the U.S vs. 25 in Japan
- Absolute Advantage in soybeans: the U.S
(Calculating Opportunity Costs)
- What you sacrifice/what you earn
Comparative Advantage
-The ability to produce a good lower at a lower opportunity cost than another
producer. (Opportunity cost: what you give up to gain something.)
- A country has a comparative advantage when a good can be produced at a lower
cost in terms of other goods. Countries should specialize in the production of goods
with comparative advantage.
- (lower than the other)
- Due to comparative advantage countries should specialize when iy comes to
international trade
Chapter 4
Market: A group of buyers and sellers of a particular good or service.
- Who are generally demanders if consumption goods and services? (Households)
- Who are generally the demanders of factors of production (land, labor, capital) (Firms)
(Demand)
Demand: market force within the economy that understands how much specific good
consumers want
Quantity Demanded:
- Amount of a good that buyers are willing and able to purchase. (Ex: Buy one iPhone or
multiple)
- Price low, demand is high and the inverse, price is high, demand can be low
Market Demand: summation of all individual demands for a good or service. (2 people in the
market and want to buy a MacBook. One wants to buy X another wants to buy X, so the total
number of those two)
(Market Demand Calculation)
- Increase in price, decrease in quantity demanded.
Question: If prices begin to rise, how will consumers respond? (Decreased Demand)
Law of Demand: As prices rise, quantity demand falls, AND that as prices fall,
quantity demanded rises. (In diagram, as prices increase to 1.20, less quantity is
demanded, which is at 40. When price decreases to 0.70, quantity demanded is
increasing to 75.)
Demand Curve: A table showing the relationship between the price of a good and the
amount that buyers are willing and able to purchase at various prices
Demand Curve Shifters (Causes in Demand shift curve)
Buyers (#): Changes in the number of consumers
- An increased consumer base also leads to an increased level of demand (people
wanting to buy more phones,etc.) and the inverse, decrease in the number of
buyers.
Income: Changes in consumers’ income level
- More money means consumers can by more products, thus increasing quantity
demanded. Vice versa for the decrease in income.
Tastes(Changes in Taste): Preference or popularity of product/service (Ex. Pandemic)
- Specific situations call for a increased need.
-This therefor alters the preference of consumers.
Expectations: Changes in what consumers expect to happen in the future
- Two ways: Expect an increase in income (demand risses)
- Expect higher prices (demand rises)
Related Goods: Compliments or Substitutes
- Substitutes: Goods where you can consume one in place of the other (competitors)
(Pepsi vs. Cola) or (If i can’t afford an iphone, substitute with something cheaper,
which could be a samsung.)
- Complements: Goods that are consumed together (mates) (Ex. Cereal and Milk go
together) (Buying a PS4, with the video games because both are needed)
Price of Complements (Mates) Increase, causes demand to decrease (Ex: wanting
to buy a PS4 and the games cost $50, then suddenly the prices rise, causing the
demand for PS4 to decrease). Inversde is also true: If the prices of games fall to
$25 dollars, making it more affordable, causing demand for PS4 to increase.
Price of Sunstitues (competitors) Increases, causes demand to increase. (Ex. both
PS4 and XBox One are both 500 dollars, but the price for the XBox falls to 400,
which can cause the demand for the XBox to rise or increase. If the opposite
happens, and the XBox prices goes up to 600 while PS4 remains at 500 the
demand for XBox will fall and demand for PS4 will increase since its a cheaper
option.
Prices of Related Goods
- Prices of Related Goods:
Substitutes, Two Goods
- An increase in the price of one
- Leads to an increase in the demand of the other
Complements, Two Goods
- An increase in the price of one
- Leads to a decrease in the demand for the other (Ex. a decrease in the price of
cocoa will cause an increase in the price of marshmallows, since they are compliments.)
Shift vs Movement
- Shift represents a complete change in demand (big shift in the graph, second line
completely to the right or completely to the left)
- Occurs when a non-price determinant of demand changes (Ex. Income or # of
buyers.)
- Movement: Represents a change in quantity demanded. (occurs when the price
changes.) ***think of law of demand** (no shifts increase just a movement due to
price)
- Normal Good, other things constant (An increase in income leads to an increase in
demand) (a good that experiences increased demand with increased income)ex:
luxurious, high end
- Inferior Good, other things constant (An increase in income leads to a decrease in
- demand)(a good that experiences decreased demand with decreased income.) ex:
everyday, average items
Supply:
-The amount of a good that is supplied to sellers. (how much sellers are gonna sell.)
- Supply acts as a measurement of how much sellers are willing to sell.
- Supply Schedule and Supply Curve” As [rices increase, quantity demanded increases,
and the inverse.
Quantity Supplied:
-The amount of supply sellers are willing to sell. (Ex: Person X:supplies 5 iphones,
and Person Y supplies 25, etc.)
Person Y: 25 (supply)
Person Z: 100 (supply)
Market Supply:
- The total sum of all supplies being sold by sellers (Ex. Add up Person X, Y, and Z
quantity supplied = 130) (adding up quantity supplied)
-
- (If prices begin to rise, how will suppliers respond?) (Increase Supply) (and the
inverse applies as well)
Law of Supply:
- States that as prices begin to rise, quantity supplied rises. AND that as
prices fall, quantity supplied falls.
-
Shifts In Supply Curve: Caused by the following:
-Technology: determines how much inputs are required
- More Efficient Technology, less inputs are needed to produce a product.
(Technological Improvements shifts to the right, and a shift to the left would
signify a technology downgrade)
-Input prices: prices either make production more or less profitable.
- Lower production costs -> incentivizes more supply. (Lower production cost,
meaning it doesn’t cost as much for suppliers to make, so it’ll produce more
supply vs. higher price inputs, which will cause a decrease in quantity supply
because of it being too expensive to make/produce.)
- True or False: Higher Taxes lead to a fall in quantity supplied (TRUE)
because the more expensive the input price is, the lower the quantity
supplied will be because it’s too expensive to make more and more of it.
-
-Number of Sellers: directly correlated with the amount of supply
- Inicreases the quantity supplied at each level
- shifts the curve to the right
-Expectations: changes in what suppliers think will happen.
- if they anticipate Good X to rise in demand or in prices, suppliers will begin to supply
more & Vice Versa (Ex. if the consumer expected an increase in prices, their
quantity demanded would rise because they would try and buy as many as they
can before the prices begin to rise high.)
- If suppliers anticipate Good X (Masks) to rise in demand or prices, suppliers will
begin to supply more. The pandemic is surging, more demand for masks, so the
supply would increase, which would cause a increase/shift in the supply curve.
- Opposite: If the pandemic begins to die down/getting out of the pandemic,
suppliers will expect that people will not buy maks as much, so the supply will
decrease, causing a shift on the left.)
Shift Vs Movement: Is there a difference between shift in the curve vs movement
along the curve? YES
- Shift: Represents a COMPLETE change in supply (Occurs when a non-price
determinant of demand changes; ex: Technological Advancement. When
technology improves, production processes are more efficient, the curve us going
to shift completely to the right.)
- Movement: Represents a change in quantity supplied (Occurs when the price
changes. No change in technology, just a price change)
(Bringing Supply and Demand Together) Pt 3
- Prices and Quantity Demanded are inversely correlated. (When price rises, quantity
demanded falls, and vice versa)
- Price and Quantity Supplied are directly correlated. (When prices rise, quantity
supplied rises, and vice versa.)
Shift Vs. Movement:
- Shift represents a complete change in demand or supply. (occurs when a
non price determinant of demand or supply changes
- Movement: a change in quantity demanded or quantity supplied. (Occurs
when the price changes.)
Market Equillibrium: The state in which the quantity supplied and the quantity
demanded are equal
- Represents both a price level that satisfies both consumers and suppliers.
(red dot in the middle)
-
- (Equilibrium)
Quantity supplied greater than quantity demanded? (Surplus– excess amount) (surplus
because we have too much supply to meet little demand)
- Surplus: Excess amount
- Shortage: Not enough
- How can a surplus be addressed by suppliers? (Decrease Prices)
- What happens when the quantity demanded is greater than the quantity supplied?
(Shortage)
- What can be done to address a shortage? (Increase the prices)
- If the prices of inputs for cocoa cola rise substantially, how will quantity supply
react? (Supply will fall because it’s to expensive to make the product.)
Three Steps in analyzing changes in equilibrium:
- Decide whether the event shifts the supply curve, the demand curve or in some cases,
both curves.
- Decide whether the curve shifts left or shifts right
- Compare the original and new equilibrium (you can then understand the effects on
equilibrium price and quantity.)
Example 1
Example 2
Example 3
- If demand increases more than supply, P rises
- If demand increases more than supply, P rises
- If supply increases more than demand, P falls.
- If both curves shift, price will fall but the effect on quantity demanded is ambiguous.
Chapter 10: Measuring a Nation’s Income
Income and Expenditure:
-Gross Domestic Product: Measures total income of everyone within a country’s
economy.
- Can also measure total expenditure in regards to a country’s output of goods and
services.
-Income = Output = Expenditure
Gross Domestic Product: (Principle 1)
-The market value of all final goods & services produced within a country in a
given period of time.
To do this, it is necessary to
- Have the same currency
- Only include legally produced and sold goods.
Principle 2:
- The GDP also acts as the final market value of all final goods and services produced
within a country in a given period of time
- Things that do NOT have a market value are excluded from GDP:
- Itemps produced at home
- items sold illicitly
- Goods are valued at their market prices, so:
- All goods measured in the same units (e.g., dollars in the U.S.)
- GDP includes all items produced in the economy and sold legally in markets
- GDP is the market value of all the FINAL GODS and services produced wihin a country
in a given tome
Principle 3 (GDP)
-Final Goods: those goods that are released and intended for consumers.(Ex.
IPhone. Designed by Apple and is intended for ME to buy. The ones being sold)
-Intermediate Goods: used as components or ingredients in the production of
other goods. (in the case of Apple, production goods such as glass, microchips, ports,
etc. used to help produce the products. NOT the ones being sold.)
- True or False: Salt is a final good, not an intermediate one. (none of the above, it could
be both! You can use it to make bread and sell the bread as well as buy it for your
own consumption.)
- True or False: GDP only covers tangible, not intangible goods and services. (False.)
GDP Includes: (Principle 4)
- The GDP also acts as the final market value of all final goods and services
produced within a country in a given period of time.
(ALL GOODS AND SERVICES ARE INCLUDED IN THE GDP)
- includes tangible goods (like food, mountain bikes, beer)
- Tangible Goods: iPhone, Whiteboard, and Monitor.)
- and intangible services (dry cleaning, concerts, haircuts).
- Intangible Goods: Spotify subscription, concerts, haircuts
Principle 5
- The GDP also acts as the final market value of all final goods aand sefrvices produced
within a country in a given period of time.)
- GDP is hard to measure when we include products made in previous time periods.
- GDP includes currently produced goods, not goods produced in the past. As
such, we only include those which were recently produced.
What is NOT in GDP?
- Intermediate goods and services
- Inputs
- Used goods
-Financial assets like stocks and bonds
- Foreign-produced goods and services
- Underground or “black market” activity
-Transfer payments
True or False: The products sold by foreign manufacturer in the US is not included in American
GDP (True! Look at what is NOT included in GDP)
- production that occurs within a country’s borders, whether done by its own
citizens or by foreigners located there —->Included in GDP
GDP– (Principle 7)
- The GDP also acts as the final goods and services produced within a country in a
given period of time.
- Usually a year or a quarter (3 months)
- Quarter Term: Short Term
- Year: Long Term
GDP:
- Final Goods
- Market: The good/service must be traded in the market and have a price.
- Domestic: Has to be produced within th economy. Subtract the value of imports
- Time: Count the year produced, NOT the year sold.’
Components of GDP
Y = C + I + G + NX
Y= GDP
C= Household Consumption
I= Firm Investment
G= Government Purchases
NX= Net exports
GDP is total spending.
- Whose expenditure? (Households– Consumption, Firms–Investment Government–
Government Purchases, People in Other Countries– Net Exports)
- These components add up to GDP(denoted Y): Y = C + I + G + NX
Consumption: (for buyers)
-Total spending by households on goods and services. (Can be durable goods)
- Products can be tangible/intangible, durable, etc.
- Does not include purchases of new housing (investment)
- Ex: Normal/regular average buyers. Going to buy an iPhone. It’s there for consumption
and uou are going to buy it.Products you will be utilizing like a phone, subscription, etc.
Investment (more for companies amd comporation)
- Total spending on goods that will be used in the future to produce goods. (ex.
Apple is the aluminium, glass, ports. These are the products and resources early on b/c
of a long term plan of building an iphone.)
- Covers inputs and resources needed in the manufacturing/production process.
- Does NOT mean purchase of financial assets.
(3 Types)
- Business Capital: Business structures, equipment, and intellectual property products
(anything to run a business.)
-Residential Capital:Housing Costs— Landlord’s apartment building; a homeowner’s
personal residence
-Inventor: Goods produced but not yet sold=. Deals heavy with supplychain.
- accumulations: goods produced but not yet sold. (aluminum, glass
- “Investment” does not mean the purchase of financial assets like stocks and bonds.
Components of GFP
- Givernmnet purchased, refers to all the spending by the government on goods and
services. (Federal, sate, and local givernmengts.)
- Excludes transfer payments: unemployment benefits, social security, etc. These are
NOT goods ard services.
- Next Exports: refer the difference between exports and imports
- Exports: refers to good and services to other nations (selling)
- Imprts: refers to goods and service sold to other nations. (lying)
Real GDP= quantity *
Chapter 11
Measuring the Costs of Living
Inflation: the increase in price. (inflation can be slow and steady or fast and rapid)
- Impacts 3 bodies: People, Government, Investors
Need to monitor over price level changes/(INFLATION)
- People: Cost of Living
- Government: Prices can impact exports and imports, and hyperinflation kills the
economy and country
- Investors: Prices to invest in something could be too high.
Since inflation impacts price levels, it is critical for one to learn how to calculate and measure it.
- Two Calculations: GDP Deflator (100 * nominal/real GDP) &CPI (Consumer Price
Index)-- shows us the costs of living/compare and contrast your GDP deflator.
What is CPI?
-The measure of overall cost of the goods and services bought by a typical
consumer.
- (monitors changes in the costs of living)
- A change in the costs of good and services = change in cost of living (Ex. more
expensive to buy phones, gas, a house, etc.)
- COL is not equal to rent. It goes to every other thing involved such as shelter,
utilities, healthcare, etc. There’s a lot more to it besides rent.
How CPI is calculated?
- Fix the Basket (Figure out what consumers typically) (Goods and Services,
i.e phones? Gas? Books? etc.)
- Find the prices (what are the prices for goods in the basket)
- Compute the basket’s cost: (Sum the prices to get the total cost)
- Choose a base year to compute CPI (Similar to real GDP)
- Compute the inflation rate: (% change in the CPI from one year to the next.)
Is CPI Perfect?
- No. It has its limitations
CPI Limitation/Problem #1: Substitution Bias (asumes that the basket is fixed)
- Basket is NOT fixed: If prices begin to rise for one good, consumers will replace it with
another good. (Substitute)
- Consumers substitute toward goods that become relatively cheaper, mitigating
the effects of price increases. The CPI misses this substitution because it uses
- a fixed basket of goods. Thus, the CPI overstates increases in the cost of
- living.
- (Whatever we have in the goods and services now, we will keep buying them over
and over again.)
- CPI, though, fails to consider the substitution effect as it utilizes a fixed basket.
- Therefore, CPI overstates increases in the cost of living.
CPI Problem #2: Introduction of New Goods:
- New goods = greater variety
- Greater variety = great dollar value
- This change in dollar value is NOT considered by CPI since it uses a fixed basket
- Therefore, the CPI overstates increases in costs of living.
- (Ex. If I buy 10 goods right now but then 5 new goods get introduced into the
market, maybe I’ll buy those goods, and now my basket increases to 15. CPI
assumes that we have a fixed basket of those 10 goods that we bought, so it fails
to consider other goods.)
CPI Problem #3: Unmeasured Quality Change
- Improvements in the good’s quality lead to a rose in the dollar value. (Playstation comes
put with new innovations/technology, which makes it even better than before, there’s
gonna be a price hike.)
- Quality is hard to measure if you utilize a fixed basket that doesnt change.
- Therefore, CPI overstates increases in costs of living.
***Problem is that CPI is fixed. It assumes that we are buying the exact same
products/goods and services over and over again. Doesn’t consider the fact that there
could be a new good in the market. Maybe apple releases a new iPhone or a cheaper
alternative, or a quality change, etc.
—--------------------------------------------------------------------------------------------------
GDP Deflator vs. CPI
-Core CPI: A measure of the overall costs of consumer goods and services excluding
food and energy. (food and energy not included in CPI)
-Producer Price Index (PPI): a measure of the costs of goods and services bought by
firms. (considering things bought by producers—- glass, aluminium, etc.)
GDP Deflator Review: the ratio of current price levels to base year price levels. (100 *
Nominal GDP/ Real GDP)
GDP Deflator can also be used to understand inflation rates from one year to the next.
Inflation rate in year 2 = (GDP Deflator in Yr 2 - GDP Deflator in year 1) / GDP Deflator in Year 1
* 100
*********(Differences)****************
Imported consumer goods: Things for us consumers (t-shirts, jeans, etc. importing them
from Australia for example)
- included in CPI but excluded from GDP deflator.
- Don’t put it in GDP because GDP doesn’t cover foreign goods, only domestic
(which are within the united states.). Ex: Buying a T-Shirt from Australia. Inclusive in
the CPI because the consumer is buying it but excluded from GDP because it is not
produced domestically (within the United States.)
Capital Goods: Goods that are often made for producers, to build products. (Ex. for apple, the
capital goods would include glass aluminum, chips, etc.)
- Excluded from CPI but included in GDP deflator if produced domestically.
-So, if goods were produced OUTSIDE of the U.S like China or Australia which is
NOT domestic, it would NOT be included in GDP. If it was domestic, which is
produced WITHIN the U.S, it would be included.)
- Consumers don’t buy capital goods, producers do. So It would be EXCLUDED
from CPI since CPI are goods and services for CONSUMERS.
- Ex: Apple uses Capital Goods like aluminum, glass, microchips, etc. Consumers are not
the ones buying the glass or aluminum so these would be EXCLUDED from CPI. It
would only be included in GDP Deflator if the goods were produced from the U.S
(Domestically) If Apple buys these goods from a producer based in the U.S and within
the U.S, it would then be included in the GDP Deflator.
The Basket:
- CPI: Goods and Services bought by consumers
-GDP Deflator: Goods and services produced DOMESTICALLY
Importance of CPI
- CPI is useful in adjusting/correcting for inflation
-Nominal value: dollar/face value of a product. (How much the Iphone cost: 500 dollars.)
-Real value of money: purchasing power (how much you can purchase varies.)
- $100 in 1930s vs $100 in today.
- They have the same nominal value, which is $100 but do they have the same real
value?
- ($100 in the 1930s, could probably buy you 30 shirts, NOW in today’s world, a
$100 dollars could get you maybe 30 shirts. Same dollar value, different purchase
power)
- CPI is useful in comparing dollar figures across time points
- Inflation mkes it difficult to make comparisons across time, so CPI simplifies this
process.
Dollar figures from Different Times:
- Comparing dollar figures from different times
- Inflation makes it harder to compare dollar amounts fro different times.
- Amount in Today’s dollars
- = amount in year T dollars * price level today/ price level in year 2
Real and Nominal Interest Rates:
- Nominal Interest Rate: (looking at dollar value as is)
- Interest rate NOT corrected for inflation
- Rate of growth in the dollar value of a deposit or debt
- The Real interest Rate: (
- Corrected for inflation
- Rate of growth in the purchasing power of a deposit or debt
Real Interest Rate = (Nominal Interest Rate) — (inflation Rate)
Chapter 15: Unemployment
BLS Divides Popeulaton into 3 groups:
Labor Force: The summation of all individuals within an economy, both employed and
unemployed. (Everybody who eligible to work/ capable to have a job)
Employed: Paid employees, self-employed, and unpaid workers in a family business.
Unemployed: Refers to individuals without a job who are currently seeking employment.
- (waiting to be recalled for a job, available for work
, tried to find employment, laid off.)
Not in the labor force: Everybody else. People who aren’t employed, who don’t have a job and
who aren’t actively seeking a job. (Ex. People who aren’t legally able to get a job, grandparents
who are retired, full time students, homemakers, too young to work, retirees, etc.)
- Labor Force = Employed + Unemplyed
Unemployment rate, u-rate : % of the labor force that is unemployed.
-U-rate = 100 x (# of unemployed / labor force)
- Rising u rate gives of the impression that the labor market is worsening and it is.
- A falling u rate gives the impression that the labor market is improving, but it is not.
Labor Force Participation Rate, LFPR : % if the adult population that is in the labor force.
-Labor-force participation rate = 100 x (labor force / adult population)
- To find Adult Population: labor force + not in labor force
Discouraged Workers: Individuals who are unemployed but are NOT currently seeking
employment
- Not interested in a job.
- Probably had to take time off of work, edging towards retirement, or just lost interest.
- Are not part of the labor force, and not a part of the unemployed, but just
classified as discouraged workers.
- This differs from the BLS definition of unemployed since discouraged workers
have no drive to pursue further work opportunities. (DONT INCLUDE IN
CALCULATION!)
(Natural Rate)
Natural Rate of Unemployment:
- The normal rate of unemployment around which the unemployment rate fluctuates.
- Up and down on the graph, all over the place, etc.
- Normal
Cyclical Unemployment:
- The deviation of unemployment from its natural rate.
- Any major changes from the natural rate we see when mappeed out on a graph
- Deviation/different
Frictional Unemplyement:
- Occurs when workers spend time searching for jobs best suited to their experience
and skills
- Short Term
- Consistently looking for a job that suits them
- School and College leavers, those searching for work between careers,
early-retired coming back into the labor market, and mothers returning to active
jobs search are all included in Frictional Unemoloyement.
- Sometimes, frictional unemployment of just inevitable:’
- Sectoral Shifts: changes in the composition of demand among industries or
regions. ( demand in the tech industry/might gave been big, but years down, the
tech industry had a lot of lay offs.)
- Changing patterns of Internation Trade (Specific country you trade a lot with.
Ex. the USA trades a lot with Saudi Arabia because Saudi Arabia has a lot of oil.
But if a war happens in Saudi Arabia, that will most likely change how much the
US trades with Saudi Arabia due to it not being in a good spot)
- Recessions
- External Factors (ex. Pandemic) (Basically anything that can make frictional
unemployment ,much more difficult.
Structural Unemployment:
- Occurs when there is a low number of jobs available for the high demand
- Not enough jobs for everyone in the market
-Usually longer-term.
- Structural unemployment happens when the wage is above equilibrium.
(Equillibrium)
Public Policy and Job Search:
Public Policy plays a key role in trying to combat unemployment, through the
implementation of new economic measures and policies to help boost employement
oppertunities for job seekers. (Addressing public issues)
- Reduce Friction (Main Thing) —> Lower natural unemployment
-Government-run employment agencies
-(provide information about job vacancies)
- Finding jobs is difficilt with job research. (Sometimes you may stumble across a
job or someone could tell you about a job at a company that you couldn’t find on
linkedin or indeed and by the time you fin out, it’s already been taken or full.)
- Trying to help people find job opportunities quicker rather than finding it on
their own.
-Public training programs:
- (equip displaced workers with skills needed in growing industries)
- (Ex. hold programming classes, projects, etc. Just ways in which training
programs are established to help develop skills for different industries.)
-Invisible Hand: argues that the market should be left to its own devices to develop,
rather than the government stopping in.
- Opponents of public policy generally cite the invisible hand in their arguments against
institutional influence in the economy.
Unemployment Insurance: financial aid provided to those who are unemployed on behalf of
the government. (Aid that the government provides)
- Ex. the pandemic. Unemployment rates skyrocketed. (anything due to external
factors/out of their control.)
Benefits of UI (Unemployment Insurance)
-Incentive:: The insurance ends the moment the indivdual becomes employed. (some
may believe or think that it’ll make people lazy and heavily reliant on the government.
The idea is that you would want more financial independence/want to be able to fund
yourself, which gives you some incentivization to go out your ebay ti find a job to gain
financial independence.)
- Reduces income uncertainty: when something happens/when you become
unemployed or laid off/let go, etc. the anxiety and phase on “whats going to happen
next?”
- It’s good because UI helps to overcome the stress/anxiety on what’s going to
happen next after something bad has happened
- Unemployed have more time to search & look for jobs that better suit their taste
and skills: (Ex. sometimes comanyies could take months to get back to you. UI just
helps people have more time find a job in the midst of other stu
- Improves the ability of the economy to match each worker with the most appropriate job
Productivity and Growth Lesson:
Productivity: Refers to the amount of output produced from each unit of labor input
- Important to track as a country’s standard of living is dependent on the amount of goods
and services produced
- Productivity = output / input
- How much output is this worker producing in an hour? 10 hrs?
- Important to track as a country’s standard of living is dependent on the amount of
goods and services produced
- Growth in productivity = growth in living standards.
- An economy’s income is its output.
- Eater income allows for greater investments, thus improving the quality of living.
- Productivity is the amount of goods and services produced for eachh hour of a workers
time. It is linked to a nation’s economic policies.
- Higher productivity = higher outputs.
Determinants of Productivity
(Increase in any one of the determinants, overall productivity will rise, greater
investments/quality of living.)
- Physical Capital or “K": Refers to the stock of equipment and structures used to
produce goods and services. (Machinery, equipment, computers, factories, power
plants, etc. All these are physical capital used to produce goods and services.)
- Human Capital: Refers to the knowledge and skills workers acquire/learn through
education, training, and experience. (Productivity is higher when the average worker has
more human capital. Such as myself.) H / L (You can have all the machinery you want
but it is useless of the people don’t know how to use that machinery.)
- Education
- Creativity, Wisdom, Abilities, Skills, Education, Experience, Etc.
- Natural Resources: Inputs into production ONLY derived from nature. (land, rivers,
mineral deposits, etc.) (how certain countries, because of their location, have
greater access to certain resources.) (Refers to your knowledge of the technology, but
not just technology, but any kind of processes that would improve your productivity.)
- Natural Resources can be the primary driver of certain economies, while
for others, it incentivizes trade.
- Technical Knowledge: Society’s understanding of the best ways to produce goods and
services.
- Any advancement that is made through research & development can help
us boost productivity.
- Boost in Productivity = Boost in Output
- Literally any kind of knowledge or piece of knowledge you have with that
specific technology from past experiences can be useful to boost our
performance, which is a boost in output.
Diminishing Returns:”Too much of everything is a bad thing” or “Less is More”
- D.R: A decline in profits and benefits as output increases
- As physical capital rises, the extra output from an additional unit of physical
capital falls.
-
- Productive Phase: Increase in inputs leads to increase in output
- Diminishing Returns: Increases are marginal when it comes to output. Upon
hitting the point of diminishing returns, every additional input will give you a much
slower output/a decline in outputs.
- Negative Returns: Returns begin to become negative. At this phase, every additional
input will give you negative returns. ( Outputs are not rising, but inputs are. Ex. Investing
money in machinery, but not producing as many goods and services as you initially
started. As you continue to invest more money into machinery, inputs are rising, but not
as many goods and services are being produced, which causes the output to decrease.)
(Example)
-
- If workers already have a lot of K or Physical Capital, giving them more productivity
increases FAIRLY LITTLE, because they already have enough physical capital and
if you're using it a lot, any further increases will be very marginal
- If workers have or are starting off with 0 capital, you have room and a lot of
potential to grow when you start implementing it.
Catch Up Effect:
- The property where countries that start off poor tend to grow more rapidly than countries
that start off rich.
- Underdeveloped nations in Africa, fro example, have a lot of room for growth. Countries
that are wholly developed, like the U.S. lack that same potential. The U.S is already fully
developed, which allows them to help or contribute to underpeopled countries.
- Refers to diminishing returns in regards to an underdeveloped country.
- Potential **
-
Public Policy (What causes productivity?, how do we increase it? What are ways of t
being implemented?)
-Public Policy: the process of addressing public issues through policy
implementation and changes. (Politics, election campaign, implementing policies
to address inflation for ex.)
- Recall that economists are scientists and policy makers.
Policymakers: What can government policy do to raise
productivity and living standards?
What can givernment policy do to raise productivity and living standards?
- Investing in Education = investing in human capital.
- Tries to boost the overall knowledge base of citizens
- Primarily involves investing greater amount of money into public education
- (Poor Countries): Can be a struggle for poorer countries with limited education
facilities.
-Brain Drain:Intellugent people move awau from poor countries, lessening
the human capital.
-Health & Nutrition = Investing in human capital
- Healthier workers = more capable workers, which increases output.
- Helps to improve the physicality of workers and their cognitive functions
- Can definitely be beneficial for more manual labor jobs.
-Saving and Investment: To raise future productivity
- Encourage saving and investment
- Invest more current resources in the production of capital, K
- Reducing consumption = increasing saving
- This extra saving funds the production of investment goods
- Investment from Abroad
- Another way for a country to invest in new capital
- Foreign direct investment
• Capital investment that is owned and operated by a foreign entity
- Foreign portfolio investment
• Investment financed with foreign money but operated by domestic residents
Property Rights and Political Stability
- Markets are usually a good way to organize economic activity.
- To foster economic growth, attract investment:
-Protect Property Rights: the ability of people to exercise authority over the
resources they own)
- Promote political stability
Free Trade:
- Trade can make everyone better off
- Inward-oriented policies
– Aim to raise living standards by avoiding interaction with other countries
- – Examples: tariffs, limits on investment from abroad
- Outward-oriented policies
- Promote integration with the world economy
- Example: elimination of restrictions on trade or foreign investment
protecting property rights and enforce contracts
Why are underdeveloped countries more ripe for economic growth?
- Catch up effect
Chapter 16: The Monetary Value
Money: The set of all assets in an economy that people regularly use to buy goods and
services from other people
- This is what pushes the market towards equilibrium
- Allows for the flow of goods and services to occur
- Critical variable to consider when discussing economics
Types of Money
- Commodity Money
- Money that takes the form of a commodity with intrinsic
- Intrinsic Value: Non-Monetary value of an item (Ex. Salt,Alcohol,
Gold, Food— things that different societies would use when they didn’t
have money )
- Goods and services that can be of value to us.
- Flat Money: Money lacking intrinsic value
- More traditional perception of money
- An asset that can only be used to buy goods and services. (Ex. the U.S
Dollar, Japanese Yen, United Arab Emirates Dirham, just currencies of
money.)
-
Functions of Money:
- Medium of Exchange: the item buyers give sellers when they want to purchase
goods and services. (You want an iPhone, but you can’t get it without giving
Apple money to buy the phone)
- Store of Value: an item that people can use to transfer purchasing power from
the present to the future. (Ex. Stocks– when you buy stocks in a firm, you slowly
but surely start to get to a level of influence within that company) **shares**
- Money holds it’s value over time. (Ex. saving money to use in the future.)
- Unit of Account: the standard unit of measurement to record money and post
prices. (ex. Currency: Canadian dollars, etc.)
- common measure of the value of goods and services being exchanged.
Wealth and Liquidity
Wealth
- The total of all stores of value, including both money and nonmonetary assets.
Liquidity:
- The ease with which an asset can be converted into the economy’s medium of
exchange. (Government/Corporate
Stocks: Bonds)
- When we think of liquidity, we think of how things can be converted into
money.)
The Money Stock
- The total collection of money held by a society at a specific time.
- A value that is constantly shifting from one period to the next
- Heavily impacted by inflation, recessions, and other major economic
occurrences.
- M1: Currency, demand deposits, traveler’s checks, and other checkable deposits.
(Refers to money in circulation along with checkable deposits from the bank.)
- Things that are extremely liquid. Things that you can quickly turn into money.
- Checks
- Treasury Bills
- Demand deposits
- Other checkable deposits
-
- M2: Everything in M1 plus savings deposits, small-time deposits, money market
mutual funds, and a few minor categories (addition to M1 with other types of
deposits and money market mutual funds.)
- A little less liquid
- Saving deposits
- Small time deposits
- Few minor categories
- CD, Money market acc
- Retail money market funds
- Long term influence, as in cannot be turmed into money quickly.
**For Calculation, M2 will always be greater than M1
******Anything that falls into M1, by definition, it is apart of M2**********
Bank Reserves (Money and the Bank)
- Reserves= Demand Deposits−Loans
- Required Reserves: Demand Deposits×Required Reserve Ratio
- Excess Reserves: (Reserve amount - required reserve amount)
- Bank Reserves: A fraction of deposits that the banks hold as reserves
- Reserve Ratio: ratio of the reserves to total deposits
- All the money left over is used to make loans
- Total Reserves include:
-Required (Set by Federal Reserve)
- Excess
- a fraction of deposits as reserves and use the rest to make loans. (Deposit
$100, 90% loaned out– $90, and 10% reserves– $10)
T- ACcounts:
- Accounting tool that maps out assets and liabilities.
- Assets: things the party owns
- Liabilities; things the party needs to pay off.
-Assets; Reserves, Loans, Securities, (stocks and bonds)
-Liabilities: (deposits, debt, and equity)
Assets_________________Liabilities
Reserves Deposits
Loans
T- Accounts:
Fractional Reserve Banking System: Refers to collections of banks that keep a fraction of
deposits as reserves and use the rest to make loans
- Banks are required to keep on hand a certain amount of cash that depositors give them.
but, banks are not required to keep the entire amount on hand.
T-Account: an accounting tool that maps out a bank’s assets and liabilities
Assets: are things the party owns
Liabilities: are things the party needs to pay off
Assets
- Reserves, Loans, Securities (stocks and bonds)
Liabilities
- Deposits, debt, and equity
- Banks liabilities include deposits
- Assets include loans and reserves
- Reserve Rato? : Reserves / Deposits = 10 / 100 = 0.1
Suppose $100 of currency is in circulation. To determine banks’ impact on money supply, we
calculate the money supply in 3 different cases:
- No banking system
- Public holds the $100 as currency
- Money supply = $100
- 100% reserve banking system (banks hold 100% of deposits as reserves, make no
loans)
-
-Fractional reserve banking system, R = 10%
Changes in money supply:
- When banks make loans, they create money
- This rise in loans also leads to a rise liabilities, balancing out the calculation done
previously
- The new result would witness an increase reflecting the rise in money supply.
- Money supply (currency + deposits)
- Reserve: no change in supply
- Fractional: change in money supply
The Money Multiplier
- Money Multiplier is the amount of money the banking system generates with each
dollar of reserves
- Change in money = change in deposits X 1 / reserve ratio
- Reserve Ratio = reserves / deposits
- Multiplier— MM ** Reserves
-
- The higher the reserve ratio the smaller the money multiplier
- This is because a higher ratio = less of each deposit bank loans out
- Consequently, the amount of money generated by the banks in reserves is
significantly smaller.
Balance Sheet:
- Financial statement covering the party’s assets, liabilities, and shareholders'
equity
- Bank Capital (Owner’s Equity): the resources a bank obtains by issuing equity to
its owners (LIABILITY)
- This involves paying off the liabilities of a bank.
- Bank Capital = Assets X Liabilties (add total assets and add total liabilities,
subtract them, which will equal 50.)
-
Leverage: supplementing existing investment funds with borrowed money.
Leverage Ratio: ratio of assets to bank capital (assets/ bank capital)
Capital Requirement: government regulation specifying a minimum amount of bank
capital.
- If bank assets appreciate by 5 %, from 2,000 to 2,100
- Bank capital increases from 100 to 200 (appreciate by 100%) doubling
owners equity
If bank assets decrease by 5%, from 2000 to 1900
- Bank capital falls from $100 to 0 (decrease by 100 %)
- If bank assets decrease more than 5%, bank capital is negative and bank is
insolvent.
(Federal Reserve Section)
Federal Reserve (FED): the central bank of the U.S.
Central Bank: an institution designed to oversee the banking system and enforce a base
quantity of money in the economy. (required to have a base amount of money in the economy)
FED’s Responsibilities:
1. regulate banks to maintain the sustainability of the banking system
- Oversees each bank's financial condition
- Enables bank transactions to occur; (if a bank wants to loan money from another
bank, the fed steps in and sets policies to allow transactions to take place.)
- Make loans to the bank in the event of an emergency
2. Develop and enforce the monetary policy of the federal open market committee
- This involves controlling the money supply by establishing a base quantity of
money that needs to be in the economy.
FOMC
- Federal Open Market Comitee (FOMC): committee consisting of all 7 members of the
board of givernmer and the 5 of the 12 regional bank presidents
- Open-Market Operations (OMO): the purchase and the sake of U.S government bonds
by the fed.
- (When you think of open, think of public and associate public with the
government.)
- Develops the monetary policy enforced by the FED
- Open Market Operations consists of:
- Buying US Government bonds to INCREASE money supply
- Sell US government bonds to decrease money supply.
Monetary Control:
- Money Supply = Money Multiplier X Money Base
- By changing either of the variables above on the right hand side, the FED can also
change the money supply (whether it is an increase or a decrease.)
- Which variable they decide to change and how much by is DEPENDENT on the context
and how they wish to change the money supply.\
- By changing either changing money multiplier or the money base, the FED can
also change the money supply.
(money supply = money base * money multiplier)
Money Base:
- OMO (open market operations)
- FED lending to banks (discount rate)
Reserve Ratio
- Minimum Requirement
- Pay Interests on reserves
How much money in supply does NOT reflect how wealthy an economy is (you can have
a lot of money supplied, but if not distributed properly, then it’s gonna affect the
economy negatively.)
Liquidity: How quickly an asset can turn into money
- Ex: checks, deposits
OMO (Open Market Operations)
- Central Bank >>>>> give out money to different, smaller banks >>>>> those banks will
give the money out to different individuals/companies
-
-
- FOMC
- Discount Rate: the interest rate paid upon by banks when borrowing from the
FED (can’t borrowing money and not expect anything in return)
- Higher Discounts Rates: (less incentivization to take money)
- Reduces discount loans to banks
- Reduces bank reserve
- Reduces money supply
- Smaller Discount Rate: (more centivized to take money from central banks)
- Increase the money supply, increasing money in economy.
Fed Tools’
- Open market operations
- Purchase and sale of securities
- Discount Lending and other lending facilities
- Discount rate affects banks’ reserves
- Reserve requirement
- Fraction of deposits required to hold in reserve
- Interest on reserves
- Changing the interest rate changes incentive to lend
Problems in Controlling the Money Supply:
- The FED does NOT control
- The amount of money that households choose to hold as deposits in banks
- The amount that bankers choose to lend
Reserve Requirement
- Minimum amount of reserves that banks must hold against deposits
- – Used rarely – disrupt business of banking
- – Less effective in recent years
- Many banks hold excess reserves
If the Fed raised the reserve requirement, the demand for reserves would
- Increase, causing the federal fund rates to rise
- Vice versa if lowered (decrease, causing the federal fund rates to lower)
(How the FED influences the reserve ratio)
- Paying interest on reserves
- The higher the interest rate on reserves
- The more reserves banks will choose to hold
An increase in the interest rate on reserves:
- Increase the reserve ratio
- Lower the money multiplier
- Lower the money supply
Chapter 17: Money Growth and Inflation
- What is inflation?
- Price level increases higher than before. Increase in the overall level of prices.
Deflation:
- Decrease in the overall prices/level of prices within an economy
Hyperinflation
- An extraordinarily high rate of inflation.
(these are all signs of economic disruptions occurring, especially when an external factor— a
pandemic– comes to play.)
3 types of inflation:
- demand-pull inflation
- When price levels rise to also increase supply in response to high demand.
(Ex. a shortage– quantity demanded is greater than quantity supplied)
- To encourage suppliers to increas supply in order to satisfy the high
demand would be to raise the price up. There is now more money to be
made.
-
- Cost-push inflation:
- When price levels rise as a result of an increase in the cost of production
inputs. (law of supply and demand put together, but gearing towards
supply)
- High cost of production causes lower demand, and lower supply
which results ti an increased price.
- Built-in inflation
- When price levels rise to meet the demands of employees who seek higher
wages. Woekrs expect the wages to increase as prices rise to help
maintain the cost of living.
The classical theory of inflation:
- Most economists rely on the quantity theory of economics to explain long-run
determinants of the pierce level and the inflation rate
- The general price level of goods and services is proportional to the money supply
in the economy
- We study this theory using two approaches:
- - supply-demand diagram
- An equation
Classical Theory:
- Classical Theory of Inflation: prices rise when the government prints too much money
- Governments print more money to ensure that there is enough currency within
the economy (Classical Theory)
- More money in the economy leads to a higher price
- Quantity Theory of Money: price level in the economy is proportional to the money
supply.
- (while this does succeed in increasing the money supply, it also sparks an
increase in prices and in turn, inflation– quantity theory)
- It assets that it us the quantity of available money (money supply) will determine
the price level. Any growth in the money supply, therefore, will be met with an
increase in such price levels. (sparking inflation)
Price Levels and Money Value
-pricelevel (P): refers to the number of dollars required to buy a specific basket of goods
and services
-Value of Money (1/P): the quantity of goods and services that can be boughtg with just
$1
- If products become more expense, it makes it difficult to purchase another good
for just $1.
- Consequently, the value of money declines the more inflation increases.
- (inversely related between value
of money and price level.)
-
Money Demand and Money Supply:
- Money demand refers to how much wealth people want to hold in liquid form (Liquid:
how ever much can be turned to cash.)
- Money demand depends on the price levels. If the price levels begin to rise, the value of
money declines. Consequently, people need more money to buy goods and services to
keep up with the more expensive products.
- Money demand is directly related to the price levels
- Money demand is INVERSLY related to the value of money.
- \
- Equilibrium:
-
-
Quantity Equation and Velocity:
- Velocity of money: refers to the rate at which money is exchanged in the economy
- Illustrates how quick money goes from one hands in the economy to the next as a
result of purchasing new goods and services.
- Y = P * Y / M
- V = velocity of money
- P * Y = Nominal GDP = (Price Level) * (Real GDP)
- M= Money Supply
The Quantity Theory of Money
- M * V = P * Y
- M= money supply
- V= velocity of circulation
- P= price level
- Y= real gdp
Chapter 20: Aggregate Demand
Economic Fluctuations:
- Recession: A period of declining incomes and rising unemployment
- Significant downturn in economic activity. A recession can cause job
losses and help or harm career opportunities.
- Depression: Severe form of a recession
- These economic fluctuations follow patterns in GDP Fluctuations:
-GDP in the short run—fluctuates around its normal rate
- (fluctuating)
Economic Fluctuations Principles:
- Principle #1: Economic fluctuations are irregular and unpredictable.
- Ex. expecting recession so banks increasing the number of reserves, pandemics
cause a recession, which was a huge economic decline. Loss of jobs, economic
decline, etc. (not expecting certain things to happen in the economy.
Economists can sometimes analyze past historical data, like if there was a steady
decline for the past 2 years, they can predict a recession to predict.)
- Typically irregular and unpredictable
- Principle #2: Most macroeconomic quantities fluctuate together.
- (things like GDP or CPI, their qualities are also
fluctuating together typically at the same rate.)
- (Whenever an economic fluctuation occurs, the macroeconomic qualities such as
GDP or CPI are also fluctuating together at the same rhythm.)
- If we see a graph with different economic measures such as GDP and CPI and they are
deviating from normal rate together at a similar kind of rate, what is happening in the
economy? : There is an economic recession happening
- Principle #3: As output falls, unemployment rises
- Ex: less employees working in the economy, less outputs being produced,
if there are less outputs, then the economy begins to see a
collapse/decline.
Economic Assumptions:
-The Classical Dichotomy: Calls for the separation of variables into two groups
-Real: quantities, relative prices
-nominal: measured in terms of money (currency exchange rates)
-Neutrality of Money: Changes in the money supply affect nominal but not real variables
Assumptions = / Reality
The classical theory describes the world in the long run, but fails to account for the short run.
- In the short run:
- We see changes in nominal variables (like money supply) affecting real variables
(like output)
- As such, we decide to implement and utilize a new model
Aggregate Demand
- :
- Looking at fluctuations and chanes within the economy
Aggregate Demand Curve
- Curve that illustrates the quantity of goods and services demanded at any price
level
- Just like with the normal demand curve, aggregate demand curve also slopes
downwards
-
- Y = C + I + G + NX (GDP Equation)
- Assume that the G in this equation is fixed by government policy
- To understand the slope of AD, we must determine how a change in P affects C, I and
NX
-
Wealth Effect: (why AD curve shifts downward, as the prices level declines, incentivizes
people to buy more, which increases in real gdp– think of the law of supply and demand
- Describes the relationship between Prices and Consumption
- If the price level declines..
- Increase the money’s real value
- Consumers are wealthier
- Increase in consumer spending
- Increases the quantity demanded
- (ex. If one becomes wealthier as a citizen, one’ll be able to afford more
expensive products and demand begins to rise, VS. if not wealthy/less
wealthy, one won’t spend as much, and your demand will be lower.
- A change in the price level, changes the purchasing power of acid causing
customers to buy more or less goods or services.
- If price level rises, value of money decreases, so people buy less
Interest Rate Effect:
- Describes the relationship between Prices and Investment
- Suppose Price level declines: (Cheaper)
- Buying goods and services require fewer dollars. People buy bonds and
other assets
- Decrease in interest rate
- Increase spending on investment goods (I)
- Increase in quantity demanded of goods and services
- a change in price level, changes the amount of savings in the economy,
which changes the interest rate. This leads to a change in borrowing and
investment (price level changes, affects interest rate, causing downward
slope)
Exchange Rate Effect:
- Describes the relationship between prices and net exports
- Suppose price level declines:
- Decrease in the US interest rate
- US dollar depreciates (decline in the real value of the dollar in foreign
exchange markets.)
- Increase in the quantity demanded of goods and services
- When prices increase in one country, other countries don’t want to buy those
higher priced goods, so they look/buy fromanother country
- a change in the price level, changes the amount that people from other countries
are willing to buy and purchase
When Price declines, GDP will go towards the right due to the
- Wealth Effect: people are able to afford/buy more products. Consuming more.
- Interest Rate: Becomes cheaper, people are able to afford more
- Exchange Rate: U.S are more cheaper, so they are more willing to trade more
often.
(INVERSE)
(since price rises, you’re not as wealthy
anymore), you’ll buy less due to the increase in price— The Wealth Effect
- Interest Rate: more expense to make investments/
- The exchange rate: gets higher/more expensive, people are less incentivized to
buy products/or even trade
Factors that can cause an increase in aggregate demand and cause a right ward shift:
- Stock market boom,
- Decrease in interest rates, causing customers/consumers to borrow and spend
more
- Increase in government spending (miltary, roads, etc.)
- Decrease taxes– causes consumers with more money to spend
- Expected Inflation– causes consumers to buy more before prices begin to rise
- Depreciation in US dollar, which would cause foreigners to find US goods less
expensive and buy more (NX)
Class Notes:
- Real GDP over the long run, the U.s grows about 3% per year on average
- GDP in the short run fluctuates around its trends
- Recessions: periods of falling real incomes and rising unemployment
- Depressions: severe recessions (very rare)
Shift: anything outside price
Movement: only when price level changes
22
Why the AD curve might shift:
Changes in C
- Stock market boom/crash
- preferences : consumption/saving trade off
- Tax hikes/cuts
Changes in I
- Firms buy new computers, equipment, factories
- – Expectations, optimism/pessimism
- – Interest rates,
- – Monetary policy,
- – Investment Tax Credit or other tax incentives
Changes in G
- Federal spending sucj as defense
- State & local spending: roads, school, etc.
Changes in NX
- Booms/recessions in countries that buy our exports
- Appreciation/depreciation resulting from international speculation in foreign exchange
market.
Active Learning: AD Curve:
- Ten yera old tax credit expires: (shift)
- The U.S exchange rate falls
- A fall in prices increases the real value of consumers’ wealth (movement)
- State governments replace their sales taxes with new taxes on interest, dividends, and
capital gains. (shift)
2. B – investment
Leftward: negative, so it’ll be ashiuft to the left
4. Consumption
- Left shift/downward shift
6. Government Purchases
- Rightward shift
8. A, B, and D
- shift , rightward
Aggregate Supply Curve:
- The AS curve shows the total quantity of goods and services firms produce and sell at
any given price level.
- AS( is)
- upward-sloping in the short run
- vertical in the long run
The natural rate of output(YN) is the amount of output the economy produces when
unemployment is at its natural rate.
- Also called potential output or full-employment output.
-
Why LRAS (long run agg. supply) is vertical:
-
Why the LRAS Curve Might Shift:
- Changes in L or natural rate of unemployment
- Immigration
- Baby-boomers retire
- Government policies reduce natural u-rate 36
- • Changes in K or H
- Investment in factories, equipment
More people get college degrees
- Factories destroyed by a hurricane
- Changes in natural resources
- Discovery of new mineral deposits
- Reduction in supply of imported oil
- Changing weather patterns that affect agricultural production
- Changes in technology
- Productivity improvements from technological progress
Shifters of Short Run Aggregate Supply Curve:
- Natural Resources:
- A change in the cost or availability of key resources will affect the amount that
producers can make in the short run.
- (if the price of resources increases, then we can’t produce as much as what
we could produce before, AS would shift to the left and vice versa. If prices
of resources decreases, then we can produce more, which would cause a
rightward shift on the AS.
- Actions by the Government:
- A change in taxes, subsidies, or regulations, can change the incentives of
producers and affect the amount they produce.
- Productivity:
- A change in technology or human capital can change the amount producers can
make with the same amount of resources.
Short Run w/ Long Run (Video Notes)
- Ex: when price level goes up, we move along the SRAS and produce more output.
Eventually people will respond to the increase of price level. If prices are going up and
people expected an inflation, then the cost or resources and/or wages, are gonna go up.
(if prices are up 5%, I’m going to ask my employer for a 5% wage increase), which would
shift the SRAS to the left, which we end up in the Long Run
- So if there is a decrease or an increase in the price level, theres going t be a short
run affect in the economy, but eventually, in the long run, wages and the cost of
resources will adjust, which will make you be right there (on the video graph) at
the long run aggregate supply.
Chapter 21: The Influence of Monetary and Fiscal Policy on Aggregate Demand
The Theory of Liquodity Preferences:
- The interest rate adjusts to being money supply and money demanded into balance
- Assumption: expected rate of inflation is constant
Money Supply:
- Assumed fixed by central bank, doesnt depend on interest rate
Money Demand:
- Reflects how much wealth people want to hold in the liquid form
- Assume household wealth includes only two assets:
- Money: Liquid but w/out interest
- Bonds: pay interest but not as liquid
Determinants of Money Demand
- Why do people demand for money?
- Transactions
- Price Level (P)
- Real Incomes (Real GDP (Y))
- Investment Return
- Interest Rate
- Financial Innovation
- Ways to expand your wealth (ex. Getting a new job, starting your own business,
etc.)
(Determinants of Money Demanded)
-The price level (P)
- The quantity of nominal money demanded is proportional to the price level
The interest rate (r)
- the opportunity cost of holding wealth in the form of money rather than an
interest-bearing asset.
- A rise in the interest rate decreases the quantity of money that people plan to hold
Real incomes (Real GDP, Y) (output)
- An increase in real GDP increases the g&s households intend to buy, which increases
the quantity of real money that people plan to hold
Variables that influence money demand:
- GDP
- Interest Rate
- Price Level
How R is determined
- MS curve is vertical
- Changes in r do not affect MS, which is fixed by the FED
- MD curve is downward sloping (impacted by the interest rate)
- A fall in r increases the quantity of money demanded
- A fall in r (interest rate) increases the quantity of money demanded. (less
interest rate = less money to spend = increase in money demanded, and
vice versa)
Money Demand
Suppose P Rises, but Y and R (interest rate) are unchanged.
- If Y (GDP) is unchanged, people will want to buy the same amount if goods and
services. (It’s unchanged, theres no reason as to why
- Since P is higher, they will need more money to do so. (increase in money
demand)
- Hence, an increase in P causes an increase in money demand, other things equal
-
How the interest rate effect works:
(a fall in P (price level) reduces money demand, which lowers r(interest rate))
-
Monetary & Fiscal Policy
Monetary Policy:
- Money supply is to be set by the central bank
Fiscal Policy
- The levels of government spending and taxation are to be set by the president and
congress.
The FED uses monetary policy to shift the AD curve
- Policy Instrument: the MOney Supply (MS)
- Targets the interest rate —-- the federal funds rate
- Banks charge each other on short term loans
- Conducts open market operations to change the MS
The FEDs Tools if Monetary Control
- Quantity of Reserves
- Open Market Operations
- Discount Rate
- Reserve Ratio
- Minimum Requirement
- Pay Interests
Effects of Increasing MS
- The FED can lower r(interest rate) by increasing the money supply
-
- A decrease in r (interest rate) increases the quantity of g&s demanded
Contractionary Policy
- Type of monetary policy where the goal is to reduce long-run inflation.
- Does so by reducing either
- Givernment spending
- Monetary expansion by central bank
- Negative consequence:
- increase in nominal interest rate and decrease in aggregate demand and real
GDP.
Liquidity Trap
- Interest rates have already fallen below zero
- Zero level bound occurs when monetary policy is no longer effective due to
liquidity trap
- Zero level bound is the cause of nominal interest rates not being able to be
reduced further
In response to the zero lower bound and the liquidity trap, the central bank can do either
of the following
- Forward guidance = raise inflationexpectations by committing to keep interest
rates low
- Quantitative easing = purchasing government bonds in order to insert money into
the economy to incite economic growth.
