ABSOLUTE ADVANTAGE 

INDIVIDUAL

  -Exists when a person can produce more of a certain good/service than someone else in the osme amount of time

NATIONAL 

   -Exists when a country can produce more of a good/service than another country can in the same time period 

COMPARATIVE ADVANTAGE 

   -A person or a nation has a comparative advantage in the production of a product when it can produce the product at a domestic opportunity cost than can a trading partner

OUTPUT Ex's                                  INPUT Ex's 

miles per gallon                                # of hours ro do a job

words per min                                  # of gallons of paint to paint a house 

apples per tree                                 # of hours to pick apples 

SPECIALIZATION AND TRADE 
    -Gains from trade are based on comparative adv. not absolute adv.
 

FOREIGN EXCHANGE 

buying and selling of currency

•  Any transaction that occurs in the balance of payments 
• The exchange rates is determine in the foreign currency markets

CHANGES IN EXCHANGE RATES 

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

           - an increase in the supply of currency with decrease the exchange rate of a currency (vice versa)

           -A increase in demand of a currency increases the exchange rate of a currency(vice versa)

APPRECIATION AND DEPRECIATION 

      -Appreciation of a currency occurs when the exchange rate of that currency increase (supply more)

      -Depreciation of a currency occurs when the exchange rate of that currency decease (demand more)

EXCHANGE RATE DETERMINANTS 

     -Consumer tastes 

     -Relative income 

     -Relative price level 

     -Speculation 

EXPORTS AND IMPORTS 

     -Exchange rate is determinant of both exports and imports

     -Appreciation of the dollar causes American goods to relatively more expensive and foreign goods to be relatively cheaper thus reducing exports and increasing imports 

     -Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively expansive thus increasing exports and reducing imports 

FLOWING RATES

     -Depends upon supply and demand of that currency verses other currency is very sensitive to the business cycle and provides options for investment  

FIXED RATES 

     -based upon a country's wiliness to distribute currency and the ability to control the amount 

UNIT 7

BALANCE OF PAYMENTS measure of money inflows and outflows between the U.S and the rest of the world

    Inflow (Credits)

    Outflows(Debits)

3 Accounts 

 1.CURRENT ACCOUNT 

     Balance of trade or net exports

        -Exports/Imports of goods and services

        -Exports create a credit to the balance of payments 

        -Imports create a debit to the balance of payments

    Net foreign income 

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

    Net transfer

        - Foreign aid= a debit to the current account 

2.CAPITAL/FINANCIAL ACCOUNT

      -The balance of capital ownership

      - Includes the purchase of both real and financial assets 

      - Direct investment in the U.S is a credit to the CA

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

RELATIONSHIP BETWEEN CURRENT AND CAPITAL 

      - They should ZERO each other out

      - If the current account has a negative balance(deficit) them the capital account should then have a positive balance(surplus)

3.OFFICIAL RESERVES

     - Foreign currency holding of the U.S federal reserve system 

     -When the balance of payments surplus the fed accumulates foreign currency and debits the balance of payments 

     - When the balance of payments deficit of the fed depletes its reserves of foreign currency and credits the balance of payments  

    - Official reserves zero out the balance of payments 

ACTIVE V. PASSIVE OFFICIAL RESERVES 
     -U.S is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate 
     -China is active

EQUATIONS 
    - Balance of trade 
          Goods exports + Goods imports
    -Balance on goods and services 
          Goods exports + Service exports + Good imports + Service imports 
    -Currents Account 
          Balance on goods and services + Net investment + Net transfers 
    -Capital Account 
          Foreign purchases + Domestic Purchases 

UNIT 5 & 6

 SHORT RUN AGGREGATE SUPPLY- period in which wages remain fixed as PL increases or decrease 

      EFFECTS:

            PL allows changes allow for companies to exceed normal outputs and hire more works b/c profits are increasing while wages remain constant  (SR)

            Wages will adjust to the PL and previous output levels will adjust accordingly (LR)

EQUILIBRIUM IN THE EXTENDED MODEL 

    extended model means the inclusion of both SR and LR curves 

DEMAND PULL inflation in the AS model DP prices increase based on increase in AD

  - SR demand pull will drive up prices and increase production 

  - LR increase in AD will eventually return to previous levels 

COST PUSH arises from factors that will increase per unit costs suck as increase in the price of a key resource 

DILEMMA FOR THE GOVT

   -In effort to flight cost push the govt can react in two different ways 

   - Action such as spending by the govt could begin an inflationary spiral

   - No action however could lead to recession by keeping production and employment levels 

LONG RUN PHILLIPS CURVE measures inflation and unemployment

    -natural rate of unemployment is held constant 

    -B/c LRPC exists at the natural rate of unemployment structural changes in the economy that affect unemployment will also cause the LRPC to shift 

RELATING PHILLIPS CURVE TO AS/AD

  - changes in AS/AS model can also be seen in the Phillips curve 

SRPC 

  -inverse relationship bwt unemployment and inflation 

LRPC

  -occurs at the nature rate of unemployment 

  -always represented by a vertical line 

  -no trade of bwt unemployment and inflation 

  -only shift if LRPS shifts 

  -If the NRU shifts so does the LRPC 

-Major assumption is that more worker benefits create higher nature rates and few worker benefits create lower nature rates 

MISERY INDEX comb. of inflation and unemployment in any given year single digit is good 2% 

SUPPLY SHOCKS rapid and efficient increase in resources cost due to oil embryo 

DISINFLATION reduction in inflation from year to year found in LRPC

DEFLATION general decline in prices 

INFLATION general rise in prices 

UNIT 4

T-account: 

• Statements of assets and liabilities 

Assets (amounts owned)

• Items to which a bank holds legal claim 
• Uses of funds by financial intermediaries

Liabilities (amounts owed)

• Legal claims against a bank
• Sources of funds for financial intermediaries  

Federal Reserve Bank

• Uses paper currency
• Holds reserves of the banks
• Lends money and charges interests
• Check clearing service for the bank
• Personal bank for the government  
• Supervises members  of banks  
• Control money supply in economy  

Reserve Requirement

• Federal requires bank to always have some money readily available to meet consumer's demand for cash 
• Amount set by the federal is required reserve
• The required reserve ratio is the % of demand deposits (checking account balance) that must not be loaned out 
• Typically its 10% 

Three types of multiple deposit expansion question

• Calculate the initial change in excess reserves:  aka the amount a single bank can loan from the initial deposit 
• Calculate the change in the money supply
• Calculate the change in the money supply: sometime type 2 and type 3 will have the same result  (if no Fed involvement)

The Reserve Requirement

• Only a small % of your bank deposit is in the safe the rest of your money has been loaned out
• This is called "Fractional Reserve Banking"
• The FED sets the amount that banks must hold
• The reserve requirement (reserve ratio) is the % of deposits that banks must hold in reserve and not loan out
• When the FED increases the money supply it increases the amount of money held in bank deposits  
• If there is a recession, what should the FED do to the reserve requirement, what should the FED do to the reserve requirement?  

 Decrease the RR 

• Banks hold less money and have more ER
• Banks create more money by loaning out excess 
• Money increase, interest rates fall, AD goes up  
• If there is inflation what should the FED do to the reserve requirement, what should the FED do to the reserve requirement?  

 Decrease the RR 

•  Banks hold more  money and have less ER 
• Banks create less money 
• Money Supply decrease, interest rates rise, AD goes down   

 The Discount Rate

• Discount Rate is  the interest rate that the FED charges commercial banks 
•  Ex: If the banks of America needs $10 million, they borrow it from the U.S Treasury (which the FED controls, but they must pay it back with interest)
• To increase the Money Supply, FED should DECREASE the Discount Rate (Easy Money Policy)
• To Decrease the Money Supply, the FED should INCREASE the Discount Rate (Tight Money Policy) 

Open Market Operations

• FED buys/sell government bonds (securities)
• This is the most important and widely used monetary policy
• To increase the MS, the FED should BUY government securities
• To decrease the MS, the FED should SELL government securities  

Monetary policy

• Expansionary: buy bonds, decrease discount rate, decrease RR = increase in loan, AD increases, GDP increase, MS increases. interest rate decreases 
• Contractionary: sell bonds, increase discount rate, increase RR= loans decrease, AD decrease. GDP decrease, MS decrease, interest rate increases   
• Federal Fund Rate: where FDIC member bank loans each other overnight funds
• Prime Rate: interest rate that banks give to their most credit- worthy customers  

UNIT 4 MONEY

Uses of Money: 

• Medium of exchange: trade or barter
• Unit of account: establishes economic worth in the exchange process -Store of value: money has its value over a period of time, where products may not  

Types of Money: 

• Commodity money: gets it value from the type of material from which it is made
•     ex: gold and silver coins 
• Representative money: paper money backed up by something tangible that it gives it value  
• Fiat Money: money because government says it is money and that is used in the U,S  

Characteristics of money: 

• portable 
• durable
• uniform
• scarce
• acceptable 
• divisible  

Money Supply:

• M1 money: currency (cash, coins, checkable deposits/ checking account, traveler's checks, and demand deposits) 
• 75% of money in circulation and it mostly liquid because it easy ti convert to cash  
• M2 money: consists of M1 money  + savings accounts and deposits held by banks held outside of the U.S

Time value of money:

Is a dollar today worth more than a dollar tomorrow?

 YES

Why?

• Opportunity cost and inflation
• Let v= future value of money
• Let p= present value of  money
• Let r= real interest rate (nominal rate- inflation rate) expressed as a decimal  
• Let n = years
• Let k= # of times interest is credited per year
• Simple interest forumla: v=  (1+r)^n * p 
• Compound interest forumla: v= (1+r/k)^nk *p 
• Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded  

What happened to the quantity demanded of money when interest rates increase?

• Quantity demanded falls because individuals would prefer to have interest rate assets instead of borrowed liabilities

What happens to the quantity demanded when interest rates decrease? 

• Quantity demanded increase, there is no incentive to convert cash into interest earning assets      
• Demand for money 

Money demand shifters:

• Change in price level
• Change in income 
• Change in taxation of investments

How money supply affects AD? 

• Money supply increases= decrease in interest rates, increase in investments, and decrease in AD
• Money supply decreases = increase in interest rate, decrease in investment, decrease in AD
• Financial Assets vs Financial Liabilities 
• FA: assets such as stocks and bonds provide expected future benefits 
• It benefits the owner, based upon the issue of the asset meeting certain obligations
• FL: liabilities incurred by financial asset to stand behind the issued asset  
• Interest rate: price paid for a financial asset 

Stocks vs Bonds: 

• Stocks: assets that convey ownership in a company
• Bonds: promise to pay a certain amount of money + interest in the future

What banks do?

• It is a financial intermediary  
• Uses liquid assets (i.e. bank deposits) to finance the investments of borrowers
• Process known as Fractional Reserve Banking
• A system in which depository institutions hold liquid assets > the amount of deposits  
• Can take form of currency in bank vaults 

          UNIT 4 MONETARY POLICY VIDEO