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

Unit III Aggregate Supply

Unit III Aggregate Supply

-The level of real  GDP (GDPr)that firms will produce at each price level (PL)

• Long Run vs. Short Run 

-Long Run: Period of time where input prices are completely flexible and adjust to changes in the price level

-Short Run: Period of time where input prices are sticky and don't adjust to change in the price - level

-Long run Aggregate Supply (LRAS):

- the LRAS marks level of fall employment in  the economy (analogous to PPC)

-B/C input prices are completely flexible in the long-run, change in price-level don't change firm's real profits and thus do not change firms level of output

   -Means LRAS is vertical vertical at economies level of full employment 

• Change in SRAS:

-An increase in SRAS it will shift right

-An decrease in SRAS it will shift left

-Key to understanding shifts in SRAS is per unit cost of production

-Per unit production cost = total input cost/ total output

• Determinants of SRAS: ( all of the following affect unit production) 

-input prices

-productivity

-legal-instituational environment  

• Input prices :

-Domestic resource prices:

-wages ( 75% of all business costs)

-cost of capital

-raw materials (Commodity Prices)

• Foreign Resource Prices:
• Market Power

-increase in resource prices = SRAS shift left

-decreases in resources prices = SRAS shift right  

• Productivity:

-total output /total input 

-more productivity = lower unit production cost = SRAS shift right  

-lower productivity = higher unit production cost = SRAS shift left

• Legal- Institutional: 

-Taxes and subsidies:

-taxes ($ to gov) on business increases per unit production cost = SRAS shifts right

-Subsidies ($ from gov) to business reduce per unit production cost = SRAS shifts right 

• Government regulation: 

-Government regulates creates a cost of compliance = SRAS shifts left

-Regulation reduces compliance costs = SRAS right 

•  Full employment:

-equilibrium exists where AD intersects SRAS & LRAS at the same point 

Unit III
Aggregate Demand Curve

• AD is the demand by consumers, businesses, government, & foreign countries  
• Change is in price level cause a move along the curve
• AD = C + Ig +G +Xn

Why is AD downwards sloping?

• Real-Balance Effect Higher price levels reduce the purchasing power of money 

-This decreases quantity of expenditure 

-Lower price levels increases purchasing power and increase expenditures 

-Ex: If the balance in your bank was $50,000, but inflation erodes your purchasing power you will likely reduce your spending  

•  Interest Rate Effect When the price level increases, lenders need to change higher interest rates to get REAL return on their loans

Higher interest rates discourage consumer spending and businesses investment. WHY?

• Foreign Trade Effect When U.S price level rises, foreign buyer's purchase fewer U.S fewer U.S good & Americans buy more foreign goods

-Exports fall and imports rise causing real GDP demanded to fall (Xn decreases) 

• Shifters of Aggregate Demand

GDP = C + Ig + G + Xn

There are 2 parts to a shift in AD 

• change in c, Ig, G, and or Xn  
• Multiplier effect that produces a greater change than the original change in components  

Increase in AD shifts AD right 

Decrease in AD shifts AD left  

 Determinants of AD 

• Consumption:

-Household spending is affected by:

Consumer wealth more wealth= more spending ( AD shifts right), less wealth= less spending ( AD shifts left)  

-Consumer Expectations

-Positive Expectations= more spending (AD shifts left) 

-Negative Expectations= more spending (AD shifts left) 

-Household indebtedness

-Less Debt = more spending ( AD shifts right )

-More Debt= less spending ( AD shits left) 

•  Taxes

-Less taxes = more spending (AD shifts right)

-More taxes = less spending (AD shifts left )

• Gross Private Investment

-Investment spending is sensitive to

-Lower real interest rate = more investment ( AD shifts right)

-Higher real interest rate = less investment (AD shifts left) 

 Expected returns

-Higher expected returns = more investment ( AD shifts right )

-Lower Expect returns = less investments ( AD shifts left )

-Expected returns are influenced by

-expectations of future profitability

-technology  

-degree of excess capacity (existing stock of capital)

-business taxes  

• Government Spending

-more government spending ( AD shifts right)

-Less government spending ( AD shifts left) 

• Next exports are sensitive to

-exchange rates ( international value of $)

-strong $ = more imports and fewer exports ( AD shifts left) 

-weak $ = fewer imports and more exports ( AD  shifts right)

-Relative Income

-Strong foreign economies = more exports  (AD shifts right) 

-Weak Foreign Economies =  less exports ( AD shifts left)