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

Unit 4 Money and Banking / Monetary Policy 

Video 1 - In this video it talked about the basic concepts of money. It introduce us to the three basic types of money which are commodity money, representative money and fiat money. Fiat money is the one we use today. Money also has functions it acts as medium of exchange, store of value and a unit of account.

Video 2- In this video it talked about money market graphs. When graphing the graph the x-axis is the quantity of money and the y-axis is price. Demand of money is downward sloping because when price is high, quantity demand is low and when price is low, quantity demand is high. Also supply money is vertical because is does not very based on the interest rate, it is fixed by the FED. 

Video 3- In this video is talked about the Feds tools of monetary. There are types which are expansionary and contractionary. If the the FED wants to expand the MS or increase MS they would decrease reserve requirement. If they want to borrow money they would decrease the discount rate or if they want to loan money they would increase the discount rate. To increase MS the FED buys bonds and to Decrease MS the FED sells bonds.

Video 4- In this video it talked about loan able funds market. Which is money that is available in the banking system for people to borrow. When graphing the x-axis is the quantity of loadable funds and the y-axis is price. The demand of loadable funds is downward sloping but supply of loadable funds is upward sloping.

Video 5- In this video it talked about the money creation process. The money creation process is banks create money by making loans. It includes money multiplier and multiple deposit expansion. The Money multiplier is 1/RR.

Video 6- In this video it talked about the connection between money market, loan able funds market, aggregate demand and supply model. If there is a change in the money market it carries over to the loan able funds market and aggregate demand. Id demand of money increase the demand of loan able funds and aggregate demand increase.When the interest rate is equal to inflation this is called The Fisher Effect. If interest rate increase by 1% inflation increase by 1%.

Unit III Discretionary vs. Automatic Fiscal Policies

Unit III Discretionary vs. Automatic Fiscal Policies

• Discretionary
  
  
  Increasing or Decreasing Government Spending and/or Taxes in order to return the economy to full employment. Discretionary policy involves policy makers doing fiscal policy in response to an economic problem.
  
  
  Example: Recession and Inflation
  
  
• Automatic

Unemployment compensation and marginal tax rates are examples of automatic policies that help mitigate the effects of recession and inflation. Automatic fiscal policy takes place without policy makers having to respond to current economic problems.

 Expansionary Fiscal Policy

• Combats Recession
• Increases Government Spending
• Decreases Taxes

Contractionary Fiscal Policy

• Combats Inflation
• Decrease in Government Spending
• Increase in Taxes

Automatic or Built-In Stabilizers

Anything that increases the government’s budget deficit during a recession and increases its budget  surplus during inflation without requiring explicit action by policy maker

Economic Importance

Taxes reduce spending and aggregate demand are desirable when the economy is moving toward inflation 

Increases in spending are desirable when the economy is heading toward recession

Unit III Fiscal Policy

Unit III Fiscal Policy

Changes in the expenditures or tax revenues of the federal government.

• 2 tools of Fiscal Policy
  -Taxes - government can increase order or decrease taxes
  -Spending - Government can increase or decrease spending

Unit III (Deficits, Surpluses, and Debt)

• Balanced Budget
  -Revenues = Expenditures
• Budget Deficit
  -Revenues < Expenditures
• Budget Surplus
  -Revenues > Expenditures
• Government Debt
  -Sum of all deficits - Sum of all Surpluses
• Government must borrow money when it runs a budget deficit. They borrow from:
  -Individuals
  -Corporations
  -Financial Institutions
  -Foreign Entities or Foreign Governments

• Fiscal Policy (Two Options)

• Discretionary Fiscal Policy (action)

-Expansionary fiscal policy - think deficit

• Contractionary fiscal policy - think surplus

Unit III The Spending Multiplier Effect

Unit III The Spending Multiplier Effect

An initial change in spending (C, IG, G, Xn) causes a larger change in any aggregate  Spending,or Aggregate Demand (AD).

Multiplier = Change in AD / Change in Spending-Multiplier = Change in AD / Change in C, I, G, or Xn

• Calculating the Spending Multiplier:

-The Spending Multiplier can be calculated from the MPC or the MPS.

-Spending Multiplier = 1 / 1 - MPC or 1 / MPS-Spending Multipliers are (+) when there is an increase spending and (-) when there is a decrease in spending.

• Calculating the Tax Multiplier:

-When the government taxes, the multiplier works increase 

-Why?  Because now $ is leaving the circular flow.

-Tax Multiplier ( note: it’s negative) -Tax Multiplier = -MPC / 1 - MPC or -MPC / MPS

-If there is a tax -CUT, then the multiplier is (+), because there is now more $ in the circular flow.

Unit III Marginal Propensity to Consume

Unit III Marginal Propensity to Consume

-The fraction of any change in disposable income that is consumed.

-MPC = Change in Consumption / Change in Disposable Income

-MPC = Change in Savings / Change in Disposable Income

• Marginal Propensities:

• MPC + MPS = 1
• MPC = 1 - MPC
• MPS = 1 - MPC
• Remember that people do two things with their disposable income, consume it or save it

Unit III Disposable Income

Unit III Disposable Income 

Income after taxes or net income.

DI = Gross Income - Taxes

-Two Choices

With disposable income, households can either :

• Consume (spend $ on goods and services)
• Save (not spend $ on goods and services)

• Consumption:

-Household Spending

-The ability to consume is constrained by:

-The amount of disposable income 

-The propensity to consume

-Do households consume if DI =0?
-No

• Saving:

-Household NOT spending 

-Ability to save is constrained by :

-Amount of DI

  - Propensity to consume

- Do households save if DI = 0?

-No

-APC and APS formulas:

• APC + APS = 1
• 1 - APC = APS
• 1 -  APS = APC
• APC > 1 (period of dissaving)
• -APS (period of dissaving)

Unit III Shifts in Investment Demand

Unit III Shifts in Investment Demand

• Cost of Production:

-Lower costs shifts ID right  

-Higher costs shifts ID left

•  Business Taxes:

-Lower business taxes shifts ID right 

-Higher business taxes shifts ID left

• Technological Change
  
  
  -New technology shifts ID right
  
  
  -Lack of technological change shifts ID left
  
  
• Stock of Capital:
  
  
  -If any economy is low on capital, then ID shifts right
  
  
  -If any economy has much capital, then ID shifts left
  
  
• Expectations:
  
  
  -Positive expectations shift ID right
  
  
  -Negative expectations shifts ID left

Unit III Invest Rates and Investment Demand

Unit III Invest Rates and Investment Demand

What is Investment?

- Money spent or expenditures on:

• New plants (factories)
• Capital equipment (machinery)
• Technology (hardware & software)
• Inventories(goods sold by producers)

Expected Rates of Return

1. How does business make investment decisions?
1. Cost/ benefit analysis
2. How does business determine the benefits?
1. Expected rate of return
3. How does business count the cost?
1. Interest costs
4. How does business determine the amount of investment they undertake?
1. Compare expected rate of return to interest cost
• If expected return > interest cost, then invest
• If expected return < interest cost, then do not invest

Real (r%) vs. Nominal (i%)

What’s the difference?

-Nominal is the observable rate of interest. Real subtracts out inflation (π%) and is only known ex post factor

1. How do you compute the real interest rate (r%)?
1. Formula: r% = i% - pi%
2. What then, determines the cost of an investment decision?
1. The real interest rate (r%)

Unit III Nominal Wages Real Wages Sticky Wages

Unit III Nominal Wages Real Wages Sticky Wages

-Nominal wages: amount of money received by a worker per unit of time 

-Real wages: amount of goods and services a worker can purchase with their nominal wages 

-"purchasing power of nominal wages"

-Sticky wages: Nominal wage level is set according to an initial price level and does not vary due to labor contracts or other restrictions