Macroeconomics Review

Chapter 1
Economic Perspective-The economic way of thinking has several components: 1. Scarcity and Choice: resources are not unlimited, but human wants are, so choices are necessary. When something is produced, something else isnt (opportunity cost). 2. Purposeful Behavior: people do things to increase their utility (pleasure gained from consuming goods and services) 3. Marginal Analysis: when making a choice, one analyzes marginal benefits and marginal costs Theories, Principles, and models. Economists base their models on the scientific method. The procedures are: 1.Observation 2. Hypothesis (an educated guess based on the observation 3. The testing of the hypothesis 4. The acceptance, rejection, or modification of the original hypothesis 5. After continuous testing, the hypothesis becomes a theory. A very well-tested theory is called an economic principle. Combinations of these laws and principles are incorporated into models, which are simplified representations of how things work Economic principles are: 1. Generalizations relating to economic behavior or to the economy itself 2. Other-Things-Equal assumption (the assumption that factors other than those being considered do not change) 3. Graphical Expression = many economic models are expressed graphically Macroeconomics vs. Microeconomics 1. Macroeconomics = focuses either on the economy as a whole, or its basic subdivisions, such as the government, households, and business sectors. 2. Microeconomics = is concerned with individual units such as a person or firm 3. Positive economics = what the economy is actually like. 4. Normative economics = what the economy should be like Individuals Economizing Problem We need to choose because we have limited income but unlimited wants.

Budget line = curve showing various combinations of 2 products a consumer can purchase with a specific money income. An increase in money income shifts the budget line to the right; a decrease in money income shifts it to the left.

Societys Economizing Problem Society must also make choices under conditions of scarcity because it has to choose between, for example, devoting money to healthcare or education. Society also has limited resources, or factors of production. These are: 1. Land = all natural resources 2. Labor = physical/mental talents of individuals 3. Capital = tools and machines 4. Entrepreneurial Ability = entrepeneurs... a. Combine resources b. Make business decisions that set the courses of enterprises c. Commercialize new products, production techniques, or forms of business organization d. Bear the risks Production Possibilities Society uses its resources to produce goods and services. We will assume: Full employment Fixed resources Fixed technology Production of only 2 goods 1. Production Possibilities table = lists the different combinations of two products that can be produced with a specific set of resources, assuming full employment. Remember: having more of something means having less of something else. 2. Production Possibilities curve = a graph of the PPtable. Points inside the curve are meh, those on the curve are the best of the best, and those outside the curve are not attainable yet. This curve illustrates the law of increasing opportunity costs. As the production of a particular good increases, the opportunity cost of producing an additional unit rises because many resources are better at producing one type of good than at producing others. Things that change the curve: Unemployment = economy produces inside PPcurve Increases in resource supply Advances in Technology Goods for the present are consumer goods (food, clothing, and entertainment)

Goods for the future = increase the quantity and quality of property resources, enlarge the stock of technological information, and improve the quality of human resources. Ex: capital goods, research and education, and preventive medicine.

Glossary: Economics = social science concerned with making choices under conditions of scarcity Economic perspective = economic way of thinking Opportunity cost = forgoing one thing to obtain another Utility = pleasure from consuming a good or service Marginal analysis = evaluating marginal costs and benefits Scientific method Economic principle = statement about economic behavior or the economy that lets us predict the outcome of certain actions Other-things-equal assumption = assumption that nothing else changes Macroeconomics = examines the economy as a whole or its basic subdivisions Aggregate = collection of specific economic units treated as one Microeconomics = examines individuals Positive economics = examines how the economy is Normative economics = examines what the economy should be like Economizing problem = the need to make choices because wants exceed needs Budget line = shows combinations of two products one can purchase with a certain income Economic resources = all resources that go into the production of resources Land = all natural resources Labor = all individual talents Capital = machines Investment = purchase of capital goods Entrepeneurial ability = ability of entrepeneurs Factors of production = resources Consumer goods =satisfy our wants directly Capital goods = satisfy our wants indirectly by making possible the production of more capital goods Production possibilities curve = displays the different combinations of goods a fullyemployed society can produce Law of increasing opportunity costs = as the production of one good increases, the opportunity cost of producing another unit rises Economic growth = a larger total output

Chapter 2
Economic Systems Every society needs an economic system and a coordinating mechanism to determine what goods are produced, how they are produced, who gets them, how to accommodate change, and how to promote technological progress. Two types: Command System A.K.A. Resources owned by Prices and amount produced changed by socialism/communism the government central planning Market System capitalism individuals AD and AS (the market)

Characteristics of the Market System 1. Private Property 2. Freedom of choice and enterprise 3. Self-interest 4. Competition 5. Markets and prices 6. Technology and capital goods 7. Specialization 7.1.Division of labor 7.2. Geographic 8. Use of money 9. Active but limited government

1. 2. 3. 4. 5.

What goods and services will be produced? Those that are in demand and profitable How will the goods and services be produced? As cheaply as possible Who will get the goods and services? Whoever can and will pay for it How will the system accommodate change? Through changes in prices and profits How will the system promote progress? By letting the best supplant the worst

The Circular Flow Model = The dynamic market economy creates continuous, repetitive flows of goods and services, resources, and money. These flows are illustrated in the Circular flow diagram

Glossary: Economic system = set of institutional arrangements and coordinating mechanism to respong to the economic problem. Command system = socialism or communism Market system = capitalism Private property = private ownership of capital Freedom of enterprise = free to obtain and use resources for production Freedom of choice = enables owners to do with their property as they see fit Self-interest = motivating force of economic units Competition = 2 or more buyers and sellers Market = brings buyers and sellers together Specialization =using resources to produce a few goods and services, not all of them Division of labor = human specialization Medium of exchange = makes trade easier (money) Barter = trading goods Money = social invention to facilitate trade Consumer sovereignty = the customer is always right Dollar votes = consumers buy what they want and can afford Creative destruction = the creation of new products obliterates old ones Invisible hand = firms and suppliers, wanting to make money, will give the people what they want Circular flow diagram = illustrates flows of goods, services, resources and money Resource market = resources are bought and sold Product market = products are bought and sold

Chapter Three
Markets bring together buyers (demanders) and sellers (suppliers). Demand = quantity of goods purchased at each price level. Law of demand = the lower the price, the higher the demand (inverse rel.) Why? Common sense Diminishing marginal utility Income effect Substitution effect *The demand curve is downward sloping because of its inverse relationship with prices By adding the quantities demanded by all consumers at each of the various possible prices, we can get from individual demand to market demand. The basic determinants of demand are 1.Consumers tastes

1. 2. 3. 4.

2.Number of buyers in the market 3.Consumers incomes 4.Prices of related goods 5.Consumer expectations. *Changes in these determinants shift the entire demand curve. Changes in quantity demanded cause a movement from one point on the curve to another. Supply = quantity of goods producers will make for sale at each price level. Law of supply = the higher the price, the higher the supply (direct rel.) *The supply curve is upsloping, reflecting this law We can add all the quantities supplied at all price levels to obtain market supply. The basic determinants of supply are 1.Resource prices 2.Technology 3.Taxes and subsidies 4.Prices of other goods 5.Producer expectations 6.Number of sellers in the market. *Changes in these determinants shift the entire supply curve. Changes in quantity supplied cause a movement from one point on the curve to another. The equilibrium price occurs where demand = supply, or where the two curves cross. Anything above that causes a surplus, anything below, a shortage. Competitive markets produce goods with productive and allocative efficiency. Government-set prices: Price ceilings Price floors Rent controls

Glossary: Demand = quantity consumed at a price level Demand schedule = shows quantity consumed at different price levels Law of demand = inverse relationship between demand and prices Diminishing marginal utility = the more you have of one good, the less you need another one Income effect = a lower price increases purchasing power Substitution effect = at lower prices, buyers will substitute other goods for that one Demand curve = graph of demand, downsloping Determinants of demand = demand shifters

Normal goods = products whose demand varies directly with money income Inferior goods = products whose demand varies inversely with money income Substitute good = replace another good Complementary good = are used with another good Change in demand = shift of the demand curve Change in quantity demanded = shift along the demand curve Supply = quantity produced at a price level Supply schedule = shows quantity produced at different price levels Law of supply = direct relationship between supply and prices Supply curve = graph of supply, upsloping Determinants of supply = supply shifters Change in supply = shift in supply curve Change in quantity supplied = movement along the supply curve Equilibrium price = price where the intentions of buyers and sellers match Equilibrium quantity = the quantity demanded and supplied Surplus = excess supply Shortage = excess demand Productive efficiency = producing as cheaply as possible Allocative efficiency = producing the best mix of goods Price ceiling = prices cannot go higher Price floor = prices cannot go lower (ex: minimum wage)

Chapter Four
Households as Income Receivers Functional distribution of income = indicates how the nations income is earned. The largest portion of income is earned in wages and salaries. Personal distribution of income = indicates how the nations money is divided among households, represented as quintiles. The highest quintile receives 50% of all income. Households as Spenders Spending = households spend on services, (-3years) nondurable goods and durable goods (+3years). Taxes = personal taxes have risen. Saving = households save about 3% of their income.

The Business Population

Plant

Firm

Industry Group of firms that produce the same or similar goods.

Physical establishment that Business organization that actually makes the goods. owns and operates plants.

Firms can be: Multi-plants a. Vertically integrated - several plants perform different stages of a process. b. Horizontally integrated - several plants doing the same thing. 2. Conglomerates - have plants that produce products in several industries. 1.

Legal Forms of Business Sole Proprietorship Owned and operated by one person. Corporation Legal creation that can perform the functions of any other enterprise. Corporate Securities: *Stocks - share in ownership of a corp. *Bonds - IOU Easy to sell = more investors. Easy to get bank loans. Limited liability - risk only what you own in stock. Hire specialists. Immortal Principal-Agent Problem Owners dont want to spend but hire managers who want to spend. Partnership Two or more individuals own and operate a business.

Advtg.

Disdvtg.

Governments Role I. Providing the Legal Structure = enforces contracts, protects the rights of private ownership, establishes the rules. II. Maintaining Competition = prohibits monopolies through regulation and antitrust. (Sherman Act of 1890). Regulated monopolies exist. III. Redistributing Income A. Transfer Payments = welfare, food stamps, unemployments. B. Market Intervention = minimum wages. C. Taxation = progressive taxation. IV. Reallocating Resources A. Externalities = when the effects of a good spill over. 1. Negative (pollution). Corrected by a) Legislation b) Specific Taxes 2. Positive (education). a) Subsidize consumers and suppliers b) Provide goods via government B. Public Goods and Services = no rivalry or excludability. Free-rider problem. C. Quasi-Public Goods = public goods that exist privately. Education, libraries, medical care, security... D. The Reallocation Process = taxing allows the government to reduce the demand for certain services and get the money to produce them themselves. V. Promoting Stability A. Unemployment = when private spending does not create enough jobs, the government increases its spending or reduces taxes so the private sector increases production. B. Inflation = when spenders try to buy more than can be produced. The government reduces spending and increases taxes so spenders buy less.

LOOK AT CIRCULAR FLOW DIAGRAM

Federal Finance Expenditures: 1. Pensions and Income Security 2. Health 3. National Defense Tax Revenues: Personal Income tax = levied on taxable income. Progressive.

1.

Marginal tax rate is the rate at which the tax is paid on each additional unit of taxable income. Average tax rate is the total tax divided by the total taxable income. 2. Payroll taxes = taxes based on wages and salaries. Fund Social Security and Medicare. 3. Corporate Income tax = levied on the profits. 4. Excise taxes = sale taxes fall on many products, excise taxes fall on few.

State Finance Expenditures: 1. Education 2. Public Welfare 3. Health 4. Highways 5. Public Safety Revenues: 1. Sales and excise taxes 2. Personal Income taxes 3. Corporate Income taxes 4. License fees

Local Finance Expenditures: 1. Education 2. Health and Welfare 3. Public Safety 4. Housing, Parks, Sewage 5. Streets and Highways Revenues: 1. Property taxes 2. Sales and excise taxes

Chapter Five
International Linkages Goods and services flows (Trade flows) = exporting and importing. Capital and labor flows (Resource flows) = foreign firms in U.S, U.S firms abroad. Information and technology flows Financial flows = money transfers

The U.S. and World Trade *Volume: The U.S.s exports are absolutely larger than other nations but a smaller percentage of GDP than other nations. *Dependence: the U.S. is almost entirely dependent on other countries. *Trade Patterns: a trade deficit occurs when imports exceed exports. U.S. in goods. A trade surplus occurs when exports exceed imports. U.S. in services.

The U.S.s main exports are: 1. Chemicals 2. Consumer durables 3. Agricultural products Its main imports are: 1. Petroleum 2. Automobiles 3. Household appliances MOST IMPORTANT TRADING PARTNER = CANADA.

Rapid Trade Growth is caused by: 1. Improved transportation and communication technology 2. Decline in tariffs (duties on imported products) Multinational corporations = firms that have large production and distribution activities in other countries.

Specialization and Comparative Advantage Specialization results in greater overall output and income. International trade is explained by comparative advantage. Comparative advantage = if nation A produces goods at a lower opportunity cost than nation B, even if B has the absolute advantage in that it can produce those goods more quickly, they should trade because A has comparative advantage.

The Foreign Exchange Market Market in which different currencies are exchanged. The equilibrium prices in these markets are called exchange rates. If a foreign currency appreciates, the dollar depreciates so exports increase and imports decrease. If the dollar appreciates, exports decrease and imports increase.

The Government and Trade Protective tariffs = taxes placed on imported goods to shift demand towards domestic products. Import quotas = limits on how many of a product can be imported. Non-tariff barriers = ridiculous licensing requirements, unreasonable quality standards, etc.

Export subsidies = government payments to domestic producers of export goods so they can lower their prices and sell more. Why does the government intervene? 1. Misunderstanding gains from trade 2. Politics = they want the vote of domestic producers.

Trade Agreements Smoot-Hawley Tariff Act = increased tariffs and caused revenge tariffs in other countries. Reciprocal Trade Agreements Act = reduced tariffs by 1. Negotiating authority - let the president negotiate 2. Generalized reductions - introduced the most-favored-nation clause (reduced tariffs to one nation apply to all the others in the group) General Agreement on Tariffs and Trade (GATT) = included many nations. World Trade Organization = GATTs successor. Critics say that it allows firms to circumvent national laws that protect workers and the environment. The European Union (EU) = free-trade zone (trade bloc) between european countries. Members use the Euro as a common currency. North American Free Trade Agreement (NAFTA) = between Canada, the U.S. and Mexico.

Chapter Six
National income accounting: 1. Assesses the health of the economy 2. Tracks the long-run course of the economy 3. Formulates policies to help improve the economy Gross Domestic Product GDP = the total market value of all FINAL goods and services produced in a year. 1. Monetary measure 2. Avoids multiple counting 2.1.Intermediate goods = are resold. Not counted 2.2. Final goods = sold to the consumer. Counted. 2.3. Value added = another way to avoid multiple counting. Its the market value of a firms output minus its inputs.

3. Excludes non-production transactions 3.1.Financial transactions 3.1.1. Public transfer payments = social security, welfare, veterans checks. 3.1.2. Private transfer payments = the money parents give kids, etc. 3.1.3. Stock market transactions = exchanging stocks and bonds. 3.2. Secondhand sales Two ways of finding GDP Expenditures C - Personal Consumption Exp. Ig - Gross private domestic investment G - Government purchases Xn - Net exports (exp - imp) Income C - Salaries and wages R - Rents I - Interest P - Corporate Profits (C.I. taxes, dividends, and profits) T - Taxes on production and imports

Net private domestic investment = gross inv - depreciation Net domestic product = GDP - depreciation National income = NDP - stat. discrepancy + net foreign factor income Personal income = NI - taxes on p&i - S.S. - C.I.taxes - C.Prof + Transfer payments Disposable income = PI - personal taxes SEE CIRCULAR FLOW DIAGRAM AGAIN

Nominal GDP based on the prices of that year

Real GDP adjusted for depreciation/appreciation

Real GDP = nominalGDP/price index(hundredths) Price index = price of market basket in one year/price in base year x 100 OR nominalGDP/RealGDP

Shortcomings of GDP

1. Non-market Activities 2. Leisure 3. Improved Product Quality 4. The Underground Economy 5. GDP and the Environment (it doesnt count pollution) 6. Composition and Distribution of output (rifle is the same as book) 7. Non-economic sources of well-being (happiness)

Chapter 7
Economic Growth Growth is an important economic goal because it lessens the burden of scarcity. Main sources of growth are: Increasing inputs Increasing productivity of existing inputs. Growth doesnt measure quality improvements or increased leisure time, but it also doesnt take into account adverse effects on the environment or human security. Business cycle: Peak - temporary maximum Recession - decline Through - temporary minimum Recovery - rise

1. 2. 3. 4.

What causes business cycles? Major innovations may trigger new investment and/or consumption spending. Changes n productivity may be a related cause. Most agree that the level of aggregate spending is important, especially changes on capital goods and consumer durables. Major changes in productivity Spending on durable (capital) goods is very unstable because they are rarely day to day necessities and easily postponed. Types of unemployment: Structural unemployment Frictional unemployment Cyclical unemployment The full-employment unemployment rate is equal to the total frictional and structural unemployment.

The population is divided into three groups: 1. Not in labor force - young or hospitalized 2. Labor force - willing and able to work (includes part-time workers) 3. Unemployed *Discouraged workers (want a job but have given up) are counted in the labor force Economic cost of unemployment: GDP gap and Okuns Law Noneconomic costs include loss of self-respect and social and political unrest. Unequal burdens of unemployment exist: Rates are lower for white-collar workers. Teenagers have the highest rates Blacks have higher rates than whites. Rates for males and females are comparable Less educated workers have higher unemployment rates Inflation: all nations have experienced it. Demand-pull inflation Cost-push inflation Inflation: Hurts fixed-income groups Hurts savers Helps borrowers but hurts lenders *If inflation is anticipated, its effects are less severe. Unexpected deflation has the opposite effects. Does inflation affect output? Cost push inflation could cause both output, real income and employment to decline. Mild inflation has uncertain effects. Danger of creeping inflation turning into hyperinflation ,which can cause speculation, reckless spending, and more inflation

Chapter 8
Income-Consumption and Income-Saving relationships Saving=Disposable income-consumption The 45 degree line on the consumption schedule is the line in which disposable income is equal to consumption, meaning no personal saving is taking place

The consumption schedule The consumption schedule is a schedule that shows the various amounts that households would plan to consume at each of the various levels of disposable income. The income-consumption schedule is upward-sloping The saving schedule The saving schedule is a schedule that shows the various amounts that households would plan on saving at each of the various levels of disposable income. There is a direct relationship between disposable income and saving. Dissaving will occur at relatively low incomes The break-even income is the income at which households plan to consume all of their income. This is shown as an intersection of the 45 degree line Average and Marginal Propensities The fraction or percentage of total income that is consumed is the Average propensity to consume (APC) The fraction or percentage of total income that is saved is the Average propensity to Save (APS) The proportion of any change in income consumed is called the Marginal propensity to consume (MPC) The fraction of any change in income saved is called the Marginal propensity to save (MPS) MPS+MPS=1 The Marginal propensity to save can be seen as the slope of the consumption or savings schedules Non-Income determinants of Demand (can cause more or less spending or saving at various income levels) The Basic Determinant = amount of disposable income 1. Wealth 2. Expectations: 3. Real Interest Rates 4. Household Debt Changes in the amount consumed: Movement from one point to another on a given schedule solely caused by change in real GDP Changes in one or more of the non income determinants of consumption: An upward or downward shift of the entire schedule Schedule shifts = consumption & saving schedules will always shift in opposite directions unless the shift is caused by a tax change

Taxation = lower taxes shift both schedules up; higher taxes shift both down Stability = consumption & saving are both stable unless altered by major tax increases or decreases. The Interest-Rate-Investment Relationship ***Investment = spending on capital goods. Relies on marginal analysis. Marginal Benefit: Expected rate of return Marginal Cost: Interest rate that must be paid for borrowed funds ***Expected Rate of Return Businesses only invest if they think such purchases will be profitable Expected economic profit (Total Revenue Total Cost) compared to cost of investment

The real interest rate is the nominal rate corrected for expected inflation Real interest rate = nominal - inflation Represents either the cost of borrowed funds or the opportunity cost of investing your own funds. If the real interest rate exceeds expected rate of return, the investment should not be made The Investment demand curve = illustrates the inverse relationship between the interest rate and the investment The investment demand curve is constructed by arraying all potential investment projects in descending order of their expected rates of return. The investment demand curve shifters: Acquisition, maintenance, and operating costs- the higher they are, the fewer investments that will take place at each possible interest rate Business Taxes- Lowers the expected rate of return Technological advance- stimulates investment with possibly cheaper and more efficient production Stock of Capital goods on hand- when firms are overstocked, investment drops. When capital is understocked, investment grows Instability of Investment Durability of capital goods = spending can be postponed Irregularity of Innovation Variability of Profits Variability of Expectations

The Ripple Effect: The economy has continuous flows of expenditures and income. Any change in income will cause both consumption & saving to vary in the same direction as the initial change in income, and by a fraction of that change. real GDP)/( spending). Multiplier= (

Marginal Propensity to Consume (MPC)-The fraction of the change in income that is spent. Size directly related to multiplier Marginal Propensity to Save (MPS)-The fraction of the change in income that is saved. Size inversely related to multiplier Multiplier = 1 / (1-MPC) Remember: MPC+MPS = 1 MPS = 1-MPC Multiplier =1 / MPS

Chapter 9
1. 2. 3. 4. 5. 6. 7. 8. AE falls = total output and employment fall. AE rises = total output and emp. rise At equilibrium, GDP = C+Ig More investment = higher GDP +net exports = GDP up -net exports = GDP down Prosperity abroad increases exports Tariffs abroad reduce exports Depreciation of the dollar increases exports while decreasing imports, appreciation decreases exports and increases imports 9. Equilibrium GDP occurs where C+Ig+G+Xn = GDP Limitations of the Model: -Doesnt show price-level changes -Ignores premature D-P inflation -Limits real GDP to Qf -Ignores C-P inflation -Doesnt allow for self-correction Basically, you know all this. Study the glossary. I I V Glossary: Planned investment = amounts business firms collectively intend to invest Investment schedule = shows the amount of investment at each level of GDP

Aggregate expenditures schedule = shows the amount spent at each possible output or income level (C+Ig) Equilibrium GDP = level at which the total quantity of goods produced (GDP) equals the goods purchased (C+Ig) Leakage = saving, withdrawal of spending from the income-expenditures stream Injection = investment, adds spending into the income-expenditures stream Unplanned changes in inventory = <-------- (see name) Net exports = exports - imports Lump-sum tax = a tax yielding the same revenue at each level of GDP Recessionary expenditure gap = amount by which aggregate expenditures at the fullemployment GDP fall short of those required to achieve full-employment GDP Inflationary expenditure gap = amount by which an economys aggregate expenditures at the full-employment GDP exceed those necessary to achieve the full-employment GDP

Chapter 10
Prices up = real GDP demanded down (and viceversa) Why does the AD curve slope downward? 1. Real-balances effect 2. Interest-rate effect 3. Foreign purchases effect Determinants of AD: Consumer spending C. wealth C. expectations C. debt Personal taxes Investment spending Interest rates Expected returns Expectations Technology Degree of excess capacity Business taxes Govt. spending Net export spending National income abroad

 Exchange rates Aggregate supply Short-run = upsloping Long-run = vertical at Qf Determinants of AS: Input prices Domestic resource prices Prices of imported resources Market power = a change in the ability to set prices above competitive levels held by sellers of major inputs Productivity Legal-Institutional environment Business taxes and subsidies Government regulation Equilibrium and changes: 1.Increases in AD = D-P inflation. Higher demand pulls prices up. 2.Decreases in AD = Recession and cyclical unemployment. Deflation can occur because prices are inflexible downwards for several reasons: a.Fear of price wars b.Menu costs c.Wage contracts d.Morale, effort, and productivity e.Minimum wage 3.Decreases in AS = C-P inflation. Higher costs of resources push prices up.

Glossary: AD-AS model = analyzes changes in real GDP and the price level Aggregate demand = curve showing the amounts of GDP that buyers decide to purchase at each price level Real-balances effect = a higher price level reduces the purchasing power of the publics savings Interest-rate effect = higher prices cause a higher demand for money, which drives up interest rates Foreign purchases effect = when the US price level rises, exports decrease and imports increase, which reduces net exports Determinants of aggregate demand = shift the demand curve Aggregate supply = curve showing the level of real domestic output that firms will produce at each price level Long-run AS curve = vertical at full-employment level

Short-run AS curve = upsloping Determinants of AS = shift the supply curve Productivity = measure of the relationship between a nations level of real output and the amount of resources used to produce it Equilibrium price level = intersection of AD and AS Equilibrium real output = what will be produced at the equilibrium price level Menu costs = cost of changing prices Efficiency wages = elicit maximum work effort and thus minimize labor costs per unit of output

Chapter 11
Fiscal policy = changes made by the government in spending and taxes to expand or contract the economy. 1. Discretionary - CEA comes up with a plan, which Congress must approve before it begins. a. Expansionary - used to counteract a recession or a cyclical downturn. Stimulates the economy by increasing aggregate demand. Creates a budget deficit (govt. spending > tax revenues). b. Contractionary 2. Non-discretionary - occurs automatically. Taxes and government transfer payments (unemployment and welfare). Problems with fiscal policy: 1.Timing a.recognition lag b.administrative lag c.operational lag 2.Political considerations 3.Future policy reversals = cant work if people expect a reversal 4.Offseting state and local finance 5.Crowding-out effect Fiscal policy is important and useful, but monetary policy works best. The Public Debt 50% is owned by US government agencies and the Federal Reserve. 25% is owned by foreigners. False concerns: 1. Bankruptcy = easily avoided with

a. Refinancing b. Taxation 2. Burdening future generations = no because most of the debt is owned by the government itself and by Americans. Real Issues: 1.Income distribution 2.Incentives (interest on the debt) 3.Foreign-owned public debt 4.Crowding-out effect

Glossary: 1. Fiscal policy = deliberate changes in government spending and tax collection designed to achieve full employment, control inflation, and encourage growth 2. Council of Economic Advisers (CEA) = group of three economists appointed by the president to provide expertise 3. Expansionary fiscal policy = tries to stimulate aggregate demand 4. Budget deficit = when government spending exceeds tax revenues 5. Contractionary fiscal policy = tries to reduce aggregate demand 6. Budget surplus = when tax revenues exceed government spending 7. Built-in stabilizer = anything that decreases budget surplus or increases deficit during a recession and does the opposite during inflation 8. Progressive tax system = the average tax rate rises with GDP 9. Proportional tax system = the average tax rate is constant 10. Regressive tax system = the average tax rate decreases as GDP rises 11. Standardized budget = full-employment budget. Measures what the budget deficit or surplus would be at full-employment output 12. Cyclical deficit = a by-product of a recession 13. Political business cycle = using fiscal policy to increase popularity 14. Crowding-out effect = an expansionary fiscal policy may increase the interest rate and reduce private spending, canceling itself out 15. Public debt = total accumulation of deficits and surpluses the Fed has incurred through time 16. US securities = financial instruments issued by the Fed to borrow money to finance excess spending not financed by tax revenues 17. External public debt = percentage of the US debt owned by foreigners 18. Public investments = increase the economys future production capacity

Chapter 12

The functions of money: Medium of exchange - used for buying and selling Unit of account - used to measure the value of goods. Easier to compare prices and calculate taxes, GDP, etc. Store of value - enables people to transfer purchasing power from the present to the future. Most liquid of all assets. Components of the money supply: 1. M1= currency+checkable dep. 1. Currency 1. Coins = token money. The value of the metal in the coin is worth less than its face value to prevent their melting down. 2. Paper Money = Federal Reserve Notes issued with the authorization of Congress. 2. Checkable Deposits (deposits in commercial banks that can be cashed). More convenient because theyre: 1. Safer 2. Theft doesnt mean youre doomed 3. Easier to write a check than count and carry large sums of money Institutions that offer checkable deposits: Commercial banks = accept deposits, keep money safe until it is demanded but meanwhile use it to make loans. Thrift institutions = savings and loan associations, mutual savings banks, and credit unions. S&Ls and mutual savings banks accept deposits and use them to provide loans. Credit unions accept deposits from and lend only to members. Checkable deposits AKA demand deposits, negotiable order of withdrawal accounts, automatic transfer service accounts and share draft accounts. *NOTE: currency owned by banks/the govt. is not counted. 2. M2 = M1+near monies 1. Near monies = assets that can become money quickly 1. Savings deposits (including MMDAs) = 1. Savings account - easy to withdraw and transfer funds 2. Money Market Deposit Account - interest-bearing account containing short-term securities. Have a minimum-balance requirement and a limit on how often funds can be withdrawn 2. Small (<$100K) time deposits = certificates of deposit (CDs) that can be cashed after a certain time without a penalty or before with large penalties. Interest rates are higher than on MMDAs. 3. Money Market Mutual Funds (MMMFs) held by individuals = mutual fund companies offer MMMFs. They use the combined funds of shareholders to buy short-term credit instruments (CDs & securities) and offer interest on the accounts of the shareholders that own them.

3. Money Zero Maturity (MZM) = M2-small time dep. + corporate MMFs MZM includes monetary balances that are immediately available for transactions without any cost. Small time deposits are not included because they cannot be freely withdrawn at any time. Corporate MMFs are included because theyre immediately available for purchases. Advantage of MZM: includes the main items (currency, CDs, MMDAs, and MMMFs) used daily and excludes time deposits, which are mostly used to save. NOTE: if something increases M1, it will increase M2 & MZM because they include M1 --------> Are credit cards money? NO. Theyre short-term loans.

What backs the money supply? The governments ability to keep the value of money relatively stable. 1. Money as Debt The major components of the money supply (paper money & checkable deposits) are promises to pay. The government manages the money supply by trying to provide the amount of money needed for business activity. This is smarter than linking money to something else, like gold, because if the supply of that thing changed rapidly the economy would experience an inflation/recession. 2. Value of Money: What gives money its value? 1. Acceptability - people accept it as a medium of exchange 2. Legal Tender - money is a legal way to pay for things. 3. Relative Scarcity - there is not an infinite supply 3. Money and Prices Prices and the dollar have an inverse relationship. The higher prices are, the less a dollar is worth. V = 1/P An economy can use money only while its value is stable, otherwise people will refuse to accept it. When the value of money changes too quickly in one country, people resort to barter, the nation takes up another official currency or other currencies are unofficially used. 4. Stabilizing Moneys Purchasing Power Rapid inflation is usually caused by imprudent economic policies. Price-level stability needs good monetary and fiscal policies. The Federal Reserve and the Banking System The monetary authorities are the members of the Board of Governors of the Federal Reserve System. The Fed controls the lending ability of banks and thrifts. Historical Background: 1. Early XXcent. = unregulated banking resulted in numerous bank notes being used. The money supply was inadequate (too little/too much) 2. 1907 = terrible banking crisis 3. Congress appointed the National Monetary Commission to outline a course of action

4.

1913 = Federal Reserve Act

Parts of the Federal Reserve: I. Board of Governors = central authority. 14-year terms to isolate from political pressure and give them experience. 7 members are appointed by the President. II. 12 Federal Reserve Banks A. Central Bank - one bank split into twelve for practical reasons. B. Quasi-Public Banks - blend private ownership and public control. Each FRB is owned by the banks in its district. However, they act in the public interest and are govt. regulated. C. Bankers Banks - perform for banks what banks do for people. Also issue currency (FR notes) III. FOMC (Federal Open Market Committee) = 12 people. A. Board of Governors (7) B. President of the NYFRB C. Presidents of FRBs, rotate every year (4) IV. Commercial Banks A. State Banks - private banks authorized by their state to operate within it B. National banks - private banks authorized by the federal govt. to operate throughout the US V. Thrifts (mostly credit unions) A. Regulated by the Treasury Departments Office of Thrift Supervision B. Still subject to control by the Fed because they have required reserves C. Monetary policy affects them just like banks Fed Functions Issuing currency Setting reserve requirements and holding reserves Lending to banks and thrifts Providing for check collection - when a check from Bank A is deposited in Bank B, the Fed adjusts their reserves accordingly 5. Acting as fiscal agent - govt. spending, tax revenues and bond exchanges occur using the Feds facilities 6. Supervising banks 7. Controlling the money supply 1. 2. 3. 4. ****The Fed is independent from the government so that politics will not interfere and it can do whats best in the long run without worrying about popularity. Recent Developments in Money and Banking

Relative decline of banks & thrifts = although theyre the only institutions that offer unrestricted checkable deposits, other institutions have expanded their shares of financial assets (see table below). Consolidation among banks & thrifts = many banks have merged with others or purchased thrifts. The point of merging is to create larger banks that compete better. Convergence of services provided by financial institutions = since 1999, banks and other financial institutions can merge and sell each others products, which is more convenient for consumers and increases competition. However, financial losses could increase the number of bank failures. Globalization of financial markets = major companies (US or foreign) are available all over the world. Electronic payments credit cards debit cards fedwire transfers - banks transfer funds to other banks automated clearinghouse transactions (ACHs) - households can send funds to businesses stored value cards (gift cards, prepaid phone cards, etc) FUTURE = electronic money (PayPal), smart cards (cards for electronic money) Major categories of the financial services industry Institution Comm. Banks Thrifts Insurance cos. Mutual fund cos. Pension funds Securities firms Description provide checking/savings accounts, sell CDs, make loans S&Ls, mutual saving banks, and credit unions offer contracts through which individuals pay to insure against some loss pool deposits by customers to buy stocks/bonds collect employee savings and buy stocks/bonds with the proceeds and make monthly retirement payments stock brokerage firms. Buy/sell stocks/bonds for clients and offer security advice

Glossary: Medium of Exchange = any item accepted by buyers and sellers (money) Unit of Account = standard unit in which prices can be stated Store of Value = an asset set aside for future use

M1 = currency (bills+coins) + checkable deposits Token money = when the face value of a coin is worth more than the metals in it Federal Reserve Notes = bills issued by the Federal Reserve. Checkable Deposits = any deposit in a comm. bank or thrift a check may be drawn against Commercial Banks = primary depository institutions Thrift Institutions = S&Ls, mutual savings banks or credit unions Near-monies = financial assets that are not a medium of exchange that is easily turned into money M2 = M1+ Near monies Savings account = a deposit in a comm. bank or thrift on which interest is received MMDA = Money Market Deposit Accounts. Bank and thrift provided interest-bearing accounts that contain short-term securities and have min. balance requirements and limited withdrawals. Time Deposits = interest-earning deposits in comm. banks or thrifts that can be withdrawn after a certain time for free or before with a large penalty MMMF = Money Market Mutual Funds. Interest-bearing accounts offered by insurance companies that pool depositors funds to purchase short-term securities. Depositors can write checks. MZM = Money Zero Maturity. M2 - small time deposits + MMMFs owned by businesses Legal Tender = legal designation of a nations official currency. Federal Reserve System = composed of 12 Federal Reserve Banks Board of Governors = monetary authorities Federal Reserve Banks = collectively serve as the nations central bank FOMC = Federal Open Market Committee Financial Services Industry = commercial banks, thrifts, insurance companies, mutual fund companies, pension funds, and securities firms Electronic Payments = credit cards, debit cards, PayPal, etc.

Chapter 13
The Fractional Reserve System Only a portion of checkable deposits are backed by cash in bank vaults or deposits at the central bank. This idea originated with the goldsmiths, who were primitive bankers. People realized gold was unsafe and inconvenient and began to deposit it and use goldsmith receipts instead. This was the first kind of paper money. The goldsmiths soon realized that people rarely took out their gold and began making loans with money they didnt really have - the beginning of the fractional reserve banking system.

Important characteristics of fractional reserve banking: Banks create money by lending (how much they can lend is limited by how much money theyre required to keep in currency reserves by the law These banks are vulnerable to panics where too many people try to withdraw their money at the same time. Highly unlikely when banks are prudent. A single Commercial Bank In the balance sheet, assets = liabilities + net worth. Transactions: 1. Creating a Bank - get permission from govt. and begin selling stock. Cash obtained is held as vault cash. 2. Acquiring Property and Equipment - making it physical 3. Accepting Deposits - Receive cash as checkable deposits 4. Depositing Reserves in the FRB reserve ratio = req. res. / checkable dep. liabil. excess res. = actual - required *Required reserves purpose is to help the Fed control the lending abilities of banks They also facilitate the clearing of checks. 5. Clearing a Check drawn against the Bank Money-Creating Transactions: 6. Granting a Loan - when banks lend money, they create checkable deposits that are actual money. The reserve ratio limits banks lending ability 7. Buying Government Securities - when a bank buys bonds from the public, it takes something that is not money and gives people money (as checkable deposits) in exchange. Profits, Liquidity, and the Federal Funds Market The asset items on a comm. banks balance sheet show the bankers conflict: Profit = why the bank makes loans and buys securities Liquidity = safety lies in the liquidity of cash and excess reserves. Bankers must balance by getting assets with high returns and highly liquid assets with no returns. They can also lend temporary excess reserves to other banks for interest (Federal Funds Rate). The Banking System: Multiple Deposit Expansion The commercial banking system can lend by a multiplier of its excess reserves because reserves lost by a single bank are deposited in another bank, so theyre not lost to the banking system. The monetary multiplier is the reciprocal of required reserve ratio. m = 1/R SO.... maximum checkable-deposit creation = excess res. X monetary multiplier (OR)

D=ExM *Since checkable deposit money is destroyed when loans are repaid, there is a multiple destruction of money, as well. Glossary: Fractional Reserve Banking System = only a portion of deposits are backed by cash Balance Sheet = statement of assets and claims that summarizes the financial position of a bank at that certain time Vault Cash = cash held by a bank Required Reserves = amount of funds equal to a specified percentage of the banks deposit liabilities Reserve Ratio = ratio of the required reserves a commercial bank must keep Excess Reserves = actual - required Actual Reserves = total money possessed by the bank Federal Funds Rate = interest rate banks charge one another on overnight loans Monetary Multiplier = 1/required reserve ratio

Chapter 14
Interest Rates Price lenders charge borrowers for the use of money. Determined by money supply and demand. Why do people demand money? Transactions demand = to buy and sell things. Directly related to nom. GDP. Assets demand = to keep it as a store of value. Inv. related to interest rates. Total demand for money = transactions demand + assets demand *Graphically, changes in nom. GDP will shift the whole curve The equilibrium interest rate is where demand and supply for money intersect. The interest rate is inversely related to bond prices. The Consolidated Balance Sheet of the Federal Reserve Banks Assets Securities short-term: bills mid-term: notes long-term: bonds Loans to Commercial Banks Liabilities Reserves of Commercial Banks

Treasury Deposits Federal Reserve Notes (bills)

Tools of Monetary Policy: 1. Open-Market Operations = exchange of govt. bonds with comm. banks or the public a. Buying i. From comm. banks: bank gives Fed bond and pays by increasing excess res. ii. From the public: person gives Fed bond, Fed gives check against itself, which is deposited in a bank, increasing checkable deposits. Excess reserves are increased minus the required reserves. b. Selling i. To comm. banks: Fed give bank bond and reduces excess res. as payment ii. To the public: Fed gives person bond and receives a check drawn against a bank. Fed reduces that banks excess and required reserves and checkable deposits 2. Reserve Ratio a. Raised - banks excess res. are diminished or depleted, in which case theyll need to contract checkable deposits and sell their bonds b. Lowered - banks gain excess reserves and can loan more. This changes the size of the monetary multiplier. 3. Discount Rate = a. Raised - doesnt want banks to borrow b. Lowered - wants banks to borrow **When banks borrow from the Fed, only their excess reserves increase. 1% above Federal Funds Rate FFR = rate banks charge one another on overnight loans. Prime interest rate = benchmark rate used by banks as a reference. Higher than FFR. Disequilibrium 1. Shortage of Money Need more money = bonds sold --> prices fall --> interest rates up --> less demand 2. Surplus of Money Need less money = bonds bought --> prices rise --> interest up --> more demand

Monetary Policy Expansionary FFR down Interest rates down (Investment up) Money supply up AD up Contractionary FFR up Interest rates up (Investment down) Money supply down AD down

Expansionary FFR down Advantages Speed Flexibility Unaffected by politics

Contractionary FFR up Disadvantages Recognition lags Operational lags Cyclical asymmetry (better for inflation)

Management Discretion = Fed should consider and choose what to do Inflation Targeting = Fed should set goals and be held accountable if it doesnt reach them. Some say role is too limited. Taylor Rule: GDP 1% > Potential GDP = FFR up 0.5pts Inflation 1% > ideal (2%) = FFR up 0.5pts When in balance = FFR 4, Real Interest Rate 2. Portrayals of the Fed: Mechanic (BEST) Warrior Fall guy Cosmic Force Glossary: Monetary Policy = series of changes made by the Federal Reserve to influence total spending and interest rates. Goal = full-employment GDP without inflation Interest = price charged for the use of money. Depends on supply & demand Transactions Demand = need for money as a method of exchange Asset Demand = need for money as a store of value Total Demand for Money = transactions + asset Open-Market Operations = the buying and selling of US securities (bonds) in the open-market (to comm. banks and the public) Reserve Ratio = percentage of checkable deposits banks must keep as vault cash or in the FRB Discount Rate = interest the Fed charges banks to loan them reserves Federal Funds Rate = interest banks charge one another when loaning reserves Expansionary Monetary Policy = monetary policy to expand real GDP Prime Interest Rate = used by banks as a benchmark Restrictive Monetary Policy = monetary policy to contract real GDP

Taylor Rule = GDP 1% > Potential GDP = FFR up 0.5pts Inflation 1% > ideal (2%) = FFR up 0.5pts When in balance = FFR 4, Real Interest Rate 2. Cyclical Asymmetry = the idea that monetary policy is better at controlling inflation than getting us out of a recession Inflation Targeting = states that the FR should set itself inflation targets and be held accountable if theyre not met

Chapter 15
Short-run AS curve: Long-run AS curve: Extended AD-AS model:

D-P inflation:

C-P inflation:

Recession:

Short-run Phillips Curve:

Long-run Phillips Curve: PC:

AS shocks and the

Laffer Curve

Glossary: Short run - period in which nominal wages and other input prices do not respond to changes in the price-level. Long run - period in which nominal wages are fully responsive to changes in the price level. Phillips Curve = demonstrates the short-run tradeoff between unemployment and inflation. Stagflation = when inflation and unemployment rise simultaneously Aggregate supply shocks = sudden, large increases in resource costs that move the short run AS curve to the left. Long-run vertical Phillips Curve

Disinflation = reductions in the rate of inflation from year to year. Supply-side economics = stress that changes in AS are an active force in determining the levels of inflation, unemployment, and economic growth. Laffer Curve = depicts the relationship between tax rates and tax revenues. It argues that lowering tax rates will increase revenues because people will stop taking taxevasion measures.

Chapter 16
Ingredients of growth: Supply i. Natural resources ii. Human resources iii. Capital goods iv. Technology 2. Demand 3. Efficiency a. Productive i. Using resources in the cheapest way... b. Allocative i. ...that provides the best mix of goods 1. Society can increase its real output and income by: 1. Increasing its inputs of resources 2. By raising the productivity of those inputs Real GDP = hours of work X labor productivity

Increase in PP:

Increase in LRAS:

Growth in Extended AD-AS model:

1. 2. 3. 4. 5. 6.

The CEA uses growth accounting to figure out what causes economic growth. There are several factors: Increases in hours of work Increases in labor productivity Technological advances Quantity of capital Education and training Economies of scale and resource allocation 6.1.Economies of scale = the larger a business is, the more efficient 6.2. Resource allocation = workers have been moving to more productive jobs (trading agriculture for manufacturing, for example)

The New Economy Caused by significant increases in productivity. 1. The microchip and information technology 2. Start-up firms that are having increasing returns because of: 2.1.More specialized inputs = the bigger, the better machines they can buy 2.2. Spreading of development costs = the more they sell, the less production costs them 2.3. Simultaneous consumption = for example, softwares can be used by thousands at once 2.4. Network effects = the more popular a product is, the more people want it 2.5. Learning by doing = workers gain experience and practice = more efficient 3. Global competition Antigrowth our economy is already wealthy, growth only satisfies trivial wants by destroying the environment we dont need more money, we need to distribute it better more growth = less time to enjoy what we are earning by working Pro-growth growth would increase all our standards of living: people would have better services and more recreation this is never gonna happen, so growth is the only option to reduce poverty the loudest protests against materialism are heard in the richest nations

Antigrowth growth is not sustainable. the earth has finite resources, the quicker we grow, the quicker they are depleted

Pro-growth growth has allowed economies to find ways of hurting the earth less

Glossary: Economic growth = increase in GDP or real output per capita Supply factors = changes in the physical and technical agents of production Demand factor = consumers must purchase what is produced or no economic growth will occur Efficiency factor = using resources in the least costly way to produce what will be sold the most. Labor productivity = real output per hour of work Labor-force participation rate = the percentage of people above working age in the labor force. Growth accounting = the bookkeeping of the supply-side elements that contribute to changes in GDP Infrastructure = highways, bridges, water systems, airports, schools, waste treatment... Human capital = knowledge and skills that make a worker productive. Economies of scale = reductions in per-unit cost that result from increases in the size of markets and firms. New economy = an economy with a higher projected trend rate of productivity growth and therefore greater potential economic growth than before. Information technology = connects all parts of the world Start-up firms = a new firm focused on creating or producing a new product Increasing returns = when a firms output increases by more than the increase in its inputs Network effects = increases in the value of the product to each user the more users there are Learning by doing = achieving greater productivity and lower average total cost through gains in knowledge and skill that accompany the repetition of a task.

Chapter 17
There are two economic perspectives:

Classical view created policy AS AD 1776, Adam Smith laissez-faire vertical, only determinant of fullemployment output only determinant of the price level. Stays stable with a constant money supply prices and wages downwardly flexible Classical view of the economy:

Keynesian view 1930s, John Maynard Keynes laissez-faire leads to recessions. need active govt horizontal because prices and wages are downwardly inflexible unstable

need fiscal and monetary policy

Keynesian view of the economy:

What causes macroeconomic instability?

Mainstream Monetarist Realbusinesscycle theory changes in technology, resource availability and productivity (changed in LRAS) Rational expectations theory (RET) A.K.A coordination failures. People anticipate what is gonna happen in the market and act accordingly New Classical Economists

changes in inv. AS shocks

Milton Friedman

markets always move towards equilibrium the economy is self-correcting

basic equation: C+Ig+G+Xn

basic equation: MV = PQ

Mainstream

Monetarist

Realbusinesscycle theory

Rational expectations theory (RET)

New Classical Economists

if V stable, changes in M = changes in PQ, or nom. GDP focus on money supply (monetarist) --> markets are competitive and provide stability

LR Phillips Curve

Monetary rule = M should grow by the amount real GDP is expected to grow

Does the economy self-correct?

New Classical monetarists or RETists the economy self-corrects, policymakers should do nothing and let it run its course debate over whether it corrects slowly (monetarists) or quickly (RETists) RETists say price-level surprises are the only thing that may take a while to correct because theyre unanticipated Mainstream downward wage inflexibility because of contracts, efficiency wages, and insider-outsider relationships

Rules or discretion?
Rules monetarists, RETists in favor of monetary rule Discretion monetary rule is flawed because velocity is very unpredictable do not think crowding out is a serious problem

Rules also favor inflation targeting

Discretion feel that fiscal policy is abused by politicians and should be reserved for special cases oppose requirements to balance budget because it could exacerbate recessions and inflation macro stability has increased in recent years, when policy has been widely used

oppose expansionary fiscal policy because they say it crowds out private investment

Glossary: Classical view = the AS curve is vertical and the sole determinant of real output Keynesian view = product prices and wages are downwardly inflexible, so the AS curve is horizontal Monetarism = focuses on the money supply, holds that markets are highly competitive, and says this competitiveness gives the economy stability Equation of exchange = MV = PQ Velocity = average number of times per year a dollar is spent on goods and services Real-business-cycle theory = business fluctuations result from significant changes in technology and resource availability Coordination failures = people fail to achieve a mutually beneficial equilibrium because they lack a way to coordinate their actions Rational expectations theory = the idea that people expect changes to have a certain effect on the economy and act accordingly New classical economics = holds that when the economy diverges from its fullemployment output, it will automatically return Price-level surprises = unanticipated changes in the price level Efficiency wage = minimizes labor costs by paying workers depending on how much they produce, encouraging them to produce more Insider-outsider theory = outsiders may not be able to underbid existing wages because employers may view the cost of hiring them as useless Monetary rule = fixed-rate expansion of the money supply regardless of circumstances

Chapter 35

Reasons to trade: More eff. production Specialization More goods and services Types of goods: 1.Land-intensive 2.Labor-intensive 3.Capital-intensive *Good because nations can find their niche PP curve is now a line because we assume constant costs Self-sufficient nation = on PP line Nations that trade = on trading line (to the right of PP) Absolute advantage = I can produce more than you Comparative advantage = It costs me less in opportunity costs to produce this A nation can expand its PP by: -Improving the quantity and quality of its resources -Technological progress -Trade!!! Pros deters monopoly more competition, innovation, choices Cons military self-sufficiency (what if theres a war against a steel provider?) diversification for stability (need to produce more than one thing in case that industry collapses) Infant industry (protect till grown) Strategic trade policy Protection against dumping Increased domestic employment Cheap foreign labor

makes nations try to cooperate

Equilibrium world price = where one nations export supply curve intersects anothers import demand curve Countries export to gain the means to import Barriers to free trade: I. Tariffs A. Protective B. Revenue II. Quotas III. Nontariff barriers IV. Voluntary export restrictions Impact: 1. Tariffs a. decline in consumption b. increased domestic production c. decline in imports d. tariff revenue e. less exports because there are less imports so there is less foreign currency 2. Quotas - same except no revenues

Glossary: Labor-intensive goods = require much skilled labor (laptops) Land-intensive goods = require much good land (corn) Capital-intensive goods = require a lot of capital (cars) Opportunity-cost ratio = the number of two products that can be produced with the same resources Principle of comparative advantage = total output will be greatest when each good is produced by the nation with the lowest opportunity cost for it. Terms of trade = exchange ratio at which two nations will trade Trading possibilities line = to the right of the PPline. Shows what nations could gain if they specialized and traded Gains from trade = try to be a sassy scholar and use that brain of yours. Hint: its what was gained from - you guessed it - trade. World price = price that equates the quantities supplied and demanded globally Domestic price = the price that would prevail in a closed economy Export supply curve = shows the amount producers will export at each world price. Upsloping because there is a direct relationship between world prices and exports. Import demand curve = shows the amounts imported at world prices above the domestic price. Downsloping because world prices and imports have an inverse relationship.

Equilibrium world price = occurs when one nations import demand curve intersects anothers export supply curve Tariffs = when the government allows imports for a certain fee Revenue tariff = applied on goods not produced internally just to give the government money Protective tariff = applied to shield domestic producers by putting foreigners at a disadvantage Import quota = limit on how much of one product can be imported Non-tariff barrier = licensing requirements, bureocratic red tape... Voluntary export restriction = foreign firms voluntarily agree to reduce exports in fear that the government will apply something that will make them reduce them more Strategic trade policy = firms protected from foreign competition can grow more quickly and be better. Dumping = selling excess goods in a foreign market at a price below cost Smoot-Hawley tariff act = its high tariffs caused a trade war and the Great Depression Trade adjustment assistance act = gives workers unemployed by international trade special benefits like cash assistance for 78 weeks Offshoring = taking work away from domestic workers and giving it to foreigners because they take smaller wages World Trade Organization = oversees trade agreements and rules on disputes Doha round = latest round of negotiations

Chapter 36
For international trade, one needs different national currencies. This problem is resolved in foreign exchange markets that facilitate exports and imports. When the US exports... 1. The foreign buyer figures out how much it has to pay in its currency and sends it to the US seller 2. The US seller needs to be paid in dollars, so it gives the check to the bank, which converts the amount into dollars and deposits the dollars in the sellers account 3. The US bank deposits the foreign currency in its correspondent foreign bank When the US imports... 1. The US buyer figures out how many dollars he must pay and buys that amount of foreign currency at the bank. 2. The US buyer sends the check to the foreign seller, who then deposits it in his bank. US exports create a foreign demand for dollars.

US imports reduce the demand for dollars. In a way, a nations exports pay for its imports. Demand and supply of a currency also arise from service transactions and the payment of interest and dividends on foreign investments. The Balance of Payments Created by the US Commerce Departments Bureau of Economic Analysis, shows flows of inpayments to and outpayments from the US. Balance of Payments Current Account US goods exports US goods imports Balance on goods US exports of services US imports of services Balance on services Balance on goods and services Net investment income Net transfers Balance on current account Capital and financial account Capital account Financial account Balance on capital account Foreign purchases of assets in the US US purchases of assets abroad Balance on financial account Balance on capital and financial account There are several types of exchange rates: FFD-FND X X BAUS-BAF CA+FA Find by X X GE-GI X X SE-SI (GE+SE)-(GI+SI) FP-USP transfers between US and the world ADD ALL

1.

Pure exchange rates a. Flexible- or floating-exchange-rate system b. Fixed-exchange-rate system Depreciation and Appreciation When a currency depreciates, more of it is needed to buy another currency. When a currency appreciates, less of it is needed to buy another currency.

Remember: If the demand for a currency increases, it will appreciate. If demand decreases, it will depreciate. 2. If the supply of a currency increases, it will depreciate. If supply decreases, it will appreciate. 3. If a nations currency appreciates, some foreign currency depreciates relative to it. 1. Determinants of Exchange Rates: Changes in tastes Relative income changes Relative price-level changes = purchasing-power-parity theory Relative interest rates Speculation = speculators are people who buy and sell currencies with an eye toward reselling or repurchasing them at a profit

1. 2. 3. 4. 5.

Flexible exchange rates = automatically adjust and eventually eliminate balance-ofpayments deficits or surpluses. Disadvantages of flexible exchange rates: 1. Uncertainty and diminished trade 2. Terms-of-trade changes 3. Instability Fixed Exchange rates = the problem is that fixing exchange rates cannot stop demand and supply from changing, and governments will have to intervene whenever a shift occurs to ensure the rate is maintained. There are several ways to achieve this: 1. Use of reserves = currency interventions 2. Trade policies = tariffs or quotas to reduce imports and subsidies to increase exports 3. Exchange controls and rationing = objections to exchange controls are... 3.1.Distorted trade 3.2. Favoritism 3.3. Restricted choice 3.4. Black markets

4.

Domestic macroeconomic adjustments = monetary and fiscal policy

International exchange-rate systems: 1. Gold standard = has the advantage of maintaining stable exchange rates and correcting balance-of-payments deficits and surpluses automatically. However, its critical drawback is that nations must accept inflation and recession. Collapsed because of the worldwide Depression in the 30s because nations devaluated their currencies. 2. Bretton Woods system = adjustable-peg system, wanted the advantages of the gold system (fixed rates) but not the disadvantages (macro adjustments). The IMF was created for this. Each nation had to define its currency in terms of gold and use their official reserves to keep it stable. Ended when there were problems with the dollar. There were three sources of needed currency: 2.1.Official reserves 2.2. Gold sales 2.3. IMF borrowing 3. Current system: Managed Float = managed floating exchange rates. Has worked much better than expected. Recent US trade deficits = rising because... The US economy grew more quickly than its trading partners, resulting in more imports and less exports. Trade deficits with China Quick rise of the price of oil Declining US saving rate These trade deficits are good because American consumers have a higher standard of living now, but they may not be able to consume that much in the future. Theyre also bad because the US technically owes foreigners. Trade deficits are a mixed blessing. Glossary: Balance of payments = sum of all the transactions that take place between a nations residents and those of all foreign nations. Current account = shows US exports and imports of goods. Balance on goods and services = difference between US exports of goods and services and US imports of goods and services. Trade deficit = unfavorable balance of trade (e<i) Trade surplus = favorable balance of trade (e>i) Balance on current account = the sum of all transactions in the current account Capital and financial account = consists of two separate accounts, the capital one and the financial one Balance on capital and financial account = sum of the capital and financial account.

1. 2. 3. 4.

Balance-of-payments deficits and surpluses = a deficit occurs when a nation must draw on its official reserves to balance the capital and financial accounts with the current account. A surplus occurs when a nation adds money to its official reserves to balance the capital and financial accounts with the current account. Official reserves = foreign currencies, reserves held in the IMF, and stocks of gold. Flexible- or floating-exchange-rate system = demand and supply determine exchange rates and in which no government intervention occurs. Fixed-exchange-rate system = governments determine exchange rates and make necessary adjustments in their economies to maintain those rates. Purchasing power-parity theory = exchange rates equate the purchasing power of various currencies - they adjust to match the ratios of the nations price levels. Currency interventions = manipulating the market through the use of official reserves Exchange controls = the government can require people to sell all they have of a foreign currency to them and ration this among importers. Gold standard = each nation must define its currency in terms of gold, maintain a fixed relationship between its stock of gold and its money supply, and allow gold to be freely imported and exported. Devaluation = a deliberate action by government to reduce the value of its currency Bretton Woods system = sought to capture the advantages of the gold standard without the disadvantages. International Monetary Fund = made the Bretton Woods system feasible and workable Managed floating exchange rates = exchange rates among major currencies are free to float but governments occasionally intervene.

NOTE: THIS IS THE FINAL REVIEW. IM ASSUMING YOU KNOW A LOT OF THIS STUFF ALREADY. IF YOURE IN THE SECOND SEMESTER, DO NOT USE THIS AS A REVIEW FOR CHAPTERS 9, 10, OR 11. THOSE ARE SHORT BECAUSE THEYRE TOO EASY AT THIS POINT. EVERYTHING ELSE I WROTE BACK WHEN I DIDNT GET MACRO. GOOD LUCK, PEOPLE.