Unit 7 - Purchasing Power Parity & Absolute Advantage v. Comparative Advantage

April 27, 2015

When the currency rate are set by international markets, changes will be based on the actual purchasing power of the currency.

Why do we exchange Currency?

• To sell exports & buy imports
• To invest in another countries stock and bonds
• To build factories or stocks in other countries
• To speculate on currency value
• To hold currencies in bank accounts, for future exports, imports, and business loans.
• To control excessive imbalances, FED control imbalances via the method of payments.

April 29, 2015

Absolute Advantage

• Individual - Exists when a person can produce more of a certain good/service than someone else in the same amount of time.
• National - Exists when a country can produce more of a good/service than the other country in the same amount of time period.

Comparative Advantage

• Individual/National - when an individual or nation can produce a good/service at a lower opportunity cost than can another individual or nation.

Input problems - This is where the country or individual can produce a set amount of something by using the least amount of resources, land, or time has the absolute advantage.

Chosen item

Forgone item

Output problem - looking at production, who can produce the best (the lowest opportunity cost)

What is given up

What is produced

Unit 7 - FOREX

April 15, 2015

Foreign Exchange (FOREX): The buying and selling of currency.

The exchange rate (e) is determined in the foreign currency market. (The exchange rate is the price of a currency)

Tips

• Always change the D line on the one currency graph, the S line in the other currency graph
• Moves lines of two currency graphs in the same direction and you will have the correct answer.
• If D on one graph moves up then so will the S on the other graph. And same if D on one graph moves left then S on the other graph will also move left.

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

• Increasing of supply in a currency will make it cheaper to buy one unit of that currency.
• Decreasing in supply of a currency will make it more expensive to buy one unit of that currency.
• Increase in demand for a currency will make it more expensive to buy one unit of that currency.
• Decrease in demand for a currency will make it more cheaper to buy one unit of that currency.

Appreciation: Appreciation of a currency occurs when the exchange rate of that currency increases

Depreciation: Depreciation of a currency occurs when the exchange rate of that currency decreases.

Exchange rate determinants

• Consumer taste
• Relative income
• Relative price level

Unit 7 - Balance of Payments

April 9, and April 13, 2015

Measure of $ inflows and outflows between the U.S and the rest of the world.

• Inflows are referred to as credits
• Outflows are referred to as debits

Balance of payments are divided into three accounts

• Current account
• Capital/Financial account
• Official reserves account

Double entry book keeping: Every entry in the balance of payments is recorded twice in accordance with standard accounting practice.

Current Account: Balance of trade or net exports

•  Balance of trade or net exports: Exports of goods and services - imports of goods and services - exports create a credit to the balance of payments - imports (Create Debt)
• Net foreign income: Income earned by U.S owned foreign assets - income paid to foreign held U.S assets.
• Net transfers: Foreign aid > Debit to the foreign account

Capital/Financial Account: The balance of capital ownership includes the purchase of both real and financial assets. Direct investments in the U.S is a credit to the capital account. Purchase of foreign financial assets represent debit to the capital account.

(relationship between current and capital account: Current and capital account should zero each other)

Official Reserves: The foreign current holdings of the U.S federal reserves system.

Active Vs. Passive: U.S is passive in its use of official reserves, doesn't seek to manipulate the dollar exchange rate.

Unit 5 & 6 - The LRPC & Supply side economics

April 6, 2015

Since the LRPC exists at the NRU structural changes in the economy that affect unemployment (Un) will also cause the LRPC to shift.

• Increase in Un will shift LRPC > 
• Decrease in Un will shift LRPC <

Supply side economics - It is the belief that the AS curve will determine levels of inflation, unemployment, economic growth. To increase economy shift AS curve to the right. Supply side economics focus on the (marginal tax rate) : The amount paid on the last dollar earned or on each additional dollar earned. They believe that lower taxis is an incentive for business to invest in the economy, also believe that lower taxes is an incentive for workers to work hard, thereby becoming more productive. Also that lower taxes incentive for people to increase savings, and therefor create lower interest rates, which causes and increase in business investment.

• Support policies that promote GDP growth by arguing that high marginal tax rates, along with the current system of transfer payment such as, unemployment compensation and welfare provide disincentives to work, invest, innovate, and under take entrepreneurship ventures. 

Reagan economics

• Lowered the marginal tax rate to get the U.S out of a recession. (Deficit) 

The Laffer Curve: Is a trade of between tax rate and government revenue used to support the supply side argument. As tax rate increase from 0% tax revenue increase to a maximum level then decline.

Criticism

• Research suggest that tax rate on incentives to work save and incest small.
• tax cuts also increase demand, which can fuel inflation, thus creating a situation were demand excessed supply.
• Were the economy is actually on the curve is difficult to determine.
  

Unit 5 & 6 - Phillip's Curve

April 2, 2015

Phillips Curve: Represents the ralationship between unemployment and inflation.

LRPC: Occurs at the NRU (seasonal, frictional, 4-5%) Represented by a vertical line. There is no trade of between unemployment and inflation. Economy produces at the full employment level (will only shift if the LRAS curve shift). LRpC major asumption is that more woker benefit creeate higher natural rates, and fewer worker benefit create lower natural rates.

SRPC:  There is a trade off between inflation and unemployment (only occur in SR) Inverse relationship. High Inflation = Low unemployment, Lower Inflation = High Unemployment
The SRPC relevance to Oakum's law. Since Wage are sticky, inflation changes more the points in the SRPC.

• If inflation persist and the expected rate of inflation rises, then the entire SRPC moves upward, which causes stagflation.
• If inflation expectation drops due to new tech or economic growth, then the SRPC moves downward.

AS (shots - Rapid and significant increase in resource cost) Cause the rate of inflation and rate of unemployment to increase. The misery index is a combo of inflation and unemployment  in any given year. Single digit misery is good. 

Unit 4 (Monetary Policy Video)

Unit 4 - Loanable Fund Market

March 23, 2015

Loanable Funds Market 

• The market where savers and borrowers exchange funds (QLF) at the real rate of interest (r%)
• The demand for loanable funds, or borrowing comes from households, firms, government and the foreign sector. The demand for loanable funds is in fact the supply of bonds.
• The supply of loanable funds, or savings comes from households, firms, government and the foreign sector. The supply of loanable funds is also the demand for bonds

Change in the demand for loanable fund

• Demand for loanable funds = Borrowing
• More borrowings = More demand for loanable funds (>)
• Less borrowing = Less demand for loanable funds (<)

Change in the supply of loanable funds

• Supply of loanable funds = Savings
• More Saving = More supply of loanable funds (>)
• Less saving = Less supply of loanable funds (<)
• Decrease in consumers MPS = Less saving = Less supply of loanable funds

When government does fiscal policy it will affect the loanable funds market.

Change in the real interest rate will affect gross private investment

Unit 4 - Monetary Policy

March 19, 2015

Tools of monetary policy

• Open Market Operation (OMO)
• Discount Rate
• Reserver Requirement

Fiscal policy

• Congress & President
• Tax and spending

Monetary policy

• The Fed (Federal Reserve Bank)
• OMO
• Discount Rate
• Federal Fund Rate
• Reserve Requirement

Discount rate: It is the interest rate that the fed charge commercial banks for borrowing money.

Federal Fund Rate: Interest rate that commercial banks charge one another for a over night loan.

Prime rate: Interest rate that banks charge their most credit worthy customers.

Unit 4 - Banks

March 17, 2015

Key principles

• A single bank can create money (through loans) by the amount of excess reserves.
• The banking system as a whole can create money by a multiple (deposition money multiplier) of the initial reserves.

Initial deposit	New or existing money	Bank reserves	Immediate change in MS
Cash- money is created in the banking system only	Existing $	Increases	No; but composition of money charges. Cash to currency.
FED purchase of a bond from the public	New	Increases	Yes; money coming from the Fed puts new dollars in circulation
Bank purchase of a bond from public	New	Increase	Yes; money is coming from reserves which puts new money in circulation.

Factors that weaken the effectiveness of the deposit multiplier

• If banks fail to loan out all of their ER.
• If banks customers take loans in cash, rather than in new checking account deposits it creates a cash or currency drain.

The Money Market (Supply & Demand)

• Demand of money has an inverse relationship between nominal interest rates and the quantity of money demanded.

Unit 4 - Creating a Bank

March 6, 2015

Transaction 

• Depositing reserves in a federal reserve bank
• Required Reservers
• Reserver Ratio (Commercial Bank's)
• Excess Reserves
• (Actual Reserves - Required Reserves)
• Required Reserves
• (Checkable deposits x Reserve Ratio)

How Banks Work

• Assets
• Reserves: Required Reserves (RR) %. Required by Fed to keep on hand to meet demand.
• Excess Reserve (ER) %. Reserves over and above the amount needed to satisfy the minimum reserve ratio set by Fed.
• Loans to firms, consumers, and other banks (earn interest)
• Loans to government = Treasury securities
• Bank property (if bank fails, you could liquidate the building/property)
• Liabilities (equity)
• Demand deposits ($ put into bank)
• Timed deposits (CD's)
• Loans from federal reserve & other banks
• Shareholders equity: To set up a bank you must invest your own money in it, to make a stake in the banks success or failure)

Unit 4 - Bonds

March 4, 2015

Bonds: Loans or IOU's that represent debt that the government or corporation must repay to a investor (Are low risk investment)

3 components

• Coupon Rate: The interest rate that a bond issuer will pay to a bond holder.
• Maturity: The time at with payment to a bond holder is due.
• Par value: The amount that an investor pays to purchase a bond and that will be paid back to the investor at maturity.

Time value of money

• Is a dollar today worth more than a dollar tomorrow?
• Yes, because opportunity cost & inflation
• This is the reason for charging & paying interest
• Interest Formula (Simple Formula  v=((1+r)^n )P) (Compound Formula  v=((1+r)^nk )P) 
• P= Present value of $
• r= real interest rate
• n= years
• k= number of times interest is credited per year

7 Functions of Fed

• Issue paper currency
• Sets reserver requirements and hold reservers of banks
• Lends money to banks and chargers them interest
• They are check clearing service for banks
• It acts a personal bank for the government
• Supervises member banks
• Controls the money supply in the economy

Types of multiple deposit expansion

• Type 1: Calculate the initial change in excess reserves
• Type 2: Calculate the change in loans in the banking system
• Type 3: Calculate the change in the money supply
• Type 4: Calculate the change in demand deposits

Unit 4 - Money

March 3, 2015

Money is any assets that can be used to purchase any goods or services.

3 uses of money

• Mediate of exchange: Determining value
• Unit of account: Comparing cost 
• Store of value: How money can be keep

3 types pf money

• Commodity money: Money that has value of it self (Salt, Olive oil, Gold)
• Representative money: Represents something of value (IOU)
• Fiat money: It is money because government say so (paper currency, Coins)

6 characteristics of money

• Durability
• Portability
• Divisibility
• Uniformity
• Limitless supply
• Acceptability 

Money supply: All the money available in the US economy made out of

• M1 money: Liquid assets (easily to convert to cash) Cash, Currency, Checkable or Demand Deposits, Travelers checks
• M2 money: (not easily converted to cash) Saving accounts, Money market accounts

3 purposes of financial institution

• Store money
• Saving money
• Loaning money (Credit cards, mortgages) 

4 ways to save money

• Savings account
• Checking account
• Money market account
• Certificate of deposits

Loans: Banks operate in a fractional reserver system

• Keep a fraction in the bank and lend out the rest.

Interest rate

• Principal: The amount of money borrowed
• Interest: Price paid for the use of borrowed money
• Simple interest: Paid on the principle
• Compound interest: Paid on the principle + accumulated interest

5 types of financial institutions

• Commercial banks
• Savings and Loan institutions
• Mutual Savings banks
• Credit union
• Fiance companies

Investment: Redirecting resources that we would consume now for future purposes

• Financial assets: Claim on property & income of the borrower
• Financial intermediates: Its an institution that channels funds from savers to borrowers

3 Purposes 

• Share risk
• Provide Information
• Liquidity

Unit 4 - Money and Banking / Monetary Policy (Videos Summaries)

Video 1

• In the first video the lady explains the three types of money.  These being; commodity money, representative money, and fiscal money.  Further on she expounds on the functions of money. Money can be a medium of exchange, store of value, and unit of account (worth).

Video 2

• During the second video the lady makes clear the money market, with the different components that we must know.  Interest rate goes in the y-axis, and quantity of money in the x-axis. The supply of money is fixed by the Fed, thus does not vary according on interest rate.  If the interest rate are unstable aggregate demand cannot be predicted.

Video 3

• The lady now goes into detail with what the Fed does to increase money supply (expansionary/easy money) and decrease money supply (contractionary/tight money). The Fed haas 3 options, they can maneuver to obtain their goal.  Change the requirer reserves, discount rate, or in OMO (Buy or sell bonds, Open Markets Operations). Reducing or increasing the requirer reserves and discount rate are incentives for the banks to react to the the change, and does not guarantee a change in the money supply.  Unlike the other two OMO put pressure to change to federal funds rate.

Video 4

• In this next video the lady describes how the loanable fund market is labeled and how is it connected to the money market.  Identical to the money market the interest rate goes to the y-axis and quantity goes to the x-axis, but converted to loanable funds. The supply of loanable funds in this case is upward slopping depending on savings for banks to be able to loan out.  The demand for more increase demand of loans thus increasing the interest rate, but i can as well decrease the supply of loanable funds.

Video 5

• During the course of this ride the lady explains how money is created through banks.  The key concepts is to know that money is created by making loans.  We use the money multiplier (1/RR) to know the maximum money supply created.  This is because of the multiple deposit system, as one deposits to a bank they take the money to make more loan and others as well take it and deposit it into another bank.  This is all in presumption that banks do not keep more that the require reservers.

Video 6

• In the last video the lady puts in view how the money market, loanable funds market, and the AD & AS graph connect. As the demand of money increases or decreases in the money market the latest rate will change, this follows to the loanable funds market. Using the fisher effect saying how interest rate and price level are in equilibrium this changes the AD & AS graph.  In consequence alternating the GDP.

Unit 3 - Fiscal Policy

February 25, 2015

Fiscal policy is the change in the expenditures or tax revenues of the federal government. Two tools of fiscal policy are Taxes & Spending.

• Deficits, Surpluses, & Debt
• Balanced budget ( Revenues = Expenditure)
• Deficit budget ( Revenues > Expenditures )
• Surplus budget ( Revenues < Expenditures )
• Government debt ( Sum of all deficits - sum of all surpluses)
• Government must borrow money when it runs a budget deficit, from
• Individuals
• Corporations
• Financial institutions
• Foreign entities or foreign countries

Fiscal policy option

• Discretionary fiscal policy (action)
• Expansionary fiscal policy (Think deficit) Designed to increase aggregate demand. Strategy for increasing GDP, combatting a recession, and unemployment. Recession countered with Increase government spending, & decrease taxes.
• Contractionary fiscal policy ( Think surplus) Designed to decrease aggregate demand. Strategy for controlling inflation, countered with increasing taxes, & decreasing government spending.
• Non-Discretionary fiscal policy (No action)

Discretionary vs Automatic fiscal policies

• Discretionary, increasing or decreasing government spending & lower taxes in order to return to economy to full employment. Involves policy makers doing fiscal policy in response to an economical problem.
• Automatic unemployment compensation & marginal tax rates are examples of automatic policies, that help mitigate the effects of recession as well as inflation. They take place without policy makers having to respond to current economic problems. Anything that increase the government budget deficit during a recession & increase its budget surplus during inflation without requiring explicit action by policy markers.

Non-Discretionary fiscal policy (Automatic stabilizer)

• Transfer payments
• Welfare checks 
• Food Stamps
• Unemployment checks
• Corporate dividend
• Social security 
• Veterans benefits
• Progressive income taxes

Progressive tax system

• Average tax rate (tax revenue / GDP ) rises with GDP
• Proportional tax system
• Average tax rate remains constant as GDP changes

Regressive tax system

• Average tax rate falls with GDP

Unit 3 - Disposable Income

February 20, 2015

With disposable income (DI) theres 2 choices households have, either consume (spend money on goods & services) or save (not spending money)

DI is income after taxes or net income. DI = Gross income - Taxes

Consumption (household spending) The ability to consume is constrained by

• The amount of DI
• The propensity to save

Do households consume if DI=0

• Autonomous consumption
•  Dissaving

        APC= C/DI = %DI that is spent

Savings (household not spending) The ability to save is constrained by

• The amount of DI
• The propensity to consume

Do households save if DI = 0

• No

       APS= S/DI = %DI that is not spent

APC & APS 

• APC + APS = 1
• 1- APC = APS
• 1- APS = APC
• APC > 1 therefore Dissaving
• APS therefore Dissaving

MPC & MPS

• Marginal propensity to consume (MPC)
• ∆ C / ∆ DI
• % of every extra dollar earned that is spent
• Marginal propensity to save (MPS)
• ∆ S / ∆ DI
• % of every dollar earned that is saved
• MPC + MPS = 1
• 1 - MPC = MPS
• 1 - MPS = MPC

The spending multiplier effect 

• An initial change in spending (C, Ig, G, Xn) causes a large change in aggregate spending or aggregate demand
• Multiplier = ∆ in AD / ∆ in spending
• Why does this happen? Expenditures and income flow continuously which sets of a spending increase in the economy.

The spending multiplier

• Can be calculated from the MPC or MPS
• Multiplier = 1 / 1 - MPC or 1 / MPS
• Positive when there is increase in spending Negative when there is a decrease

The tax multiplier

• When government taxes, the multiplier works in reverse
• Why? Because now money is leaving the circular flow 
• Tax multiplier (Its negative) = - MPC / 1 - MPC  or - MPC / MPS
• If there is a tax cut, then the multiplier is positive, because there is now more money in the circular flow.

Unit 3 - Three schools of economics

February 19, 2015

Three schools of economy ( Classical, Keynesian, Monetary)

Points of Classical school

•  Investment (Injection)
• AS determines output
• Market works by it self (No government intervention)
• Savings increase with interest rate
• AS=AD at full employment equilibrium
• In the LR the economy will balance at full employment (economy close to or at full employment)
• Believe in the trickle down effect ( this is were you help the rich first and everyone else latter)
• Prices and wages are flexible downward

Points of Keynesian school

• Competition is flawed (AD is key not AS)
• Demand creates its own supply
• Savers and investors save for different reasons
• Saving are inverse to interest rate
• Leaks cost constant recessions and savings cause recessions
• Ratchet effects and sticky wages block state law
• Price/wages are inflexible downward
• No mechanism capable of guaranteeing full employment
• The economy is not close to or at full employment
• Government intervention (expansionary & contractionary policies (Fiscal policy) 

Points of Monetary school

• Fine tuning is needed, congress can't time the policy options (voters wont allow it)
• Contractionary option
• Easy and tight money 
• Change the required reserves if needed
• Buy & sell bonds in open market
• Change in interest rate for the discount rate & federal fund rate

Unit 3 - Investment Demand Curve

February 18, 2015

The investment demand curve is downward sloping. This is because when interest rates are high, fewer investments are profitable; when interest rate are low, more investments are profitable.

Shifts in Investment Demand

• Cost of production
• Lower cost (Dig Shift >)
• Higher cost (Dig Shift <)
• Business Taxes
• Lower business taxes (Dig Shift >)
• Higher business taxes (Dig Shift <)
• Technological ∆
• New technology (Dig Shift >)
• Lack of technological changes (Dig Shift <)
• Stock of capital
• If an economy is low on capital (Dig Shift >)
• If an economy has much capital (Dig Shift <)
• Expectations
• Positive expectations (Dig Shift >)
• Negative expectations (Dig Shift <)

Unit 3 - Full Employment / Interest rate $ Investment demands

February 17, 2015

Full employment equilibrium exists where AD intersects SRAS & LRAS at the same point.

Recessionary gap exists when equilibrium occurs below full employment output.

Inflationary gap exists when equilibrium occurs beyond full employment output.

Investment rates and investment demand, investment is money spent or expenditures on:

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

Expected rates of return

• How does business make investment decisions? Cost/benefit analysis
• How does business determine the benefits? Expected rate of return
• How does business count cost? Interest cost
• How does business determines the amount of investment they undertake? Compare expected rate of return to interest cost
• If expected return > interest cost (then invest)
• If expected return < interest cost (then don't invest)

Real vs Nominal interest rate

• Nominal is the observable rate of interest i. Real subtracts out inflation (pie interest) and is only known ex post facto
• To compute real interest rate: R% (real) = i% (nominal) - pie (compute)

Unit 3 - Aggregate supply

February 12, 2015

The aggregate supply curve depicts the quantity of real GDP that is supplied by the economy at different price levels.

Long Run vs Short Run

• Long run: Period of time where input prices are completely flexible and adjust to changes in the price level. In the long run the level of real GDP supplied is independent of the price level.
• Short run: Period of time where input prices are sticky and do not adjust to changes in the price level. In the short run the level of real GDP supplied is directly related to the price level.

Long Rund Aggregate Supply (LRAS): Marks the level of full employment in the economy (analogous to PPC) because input prices are completely flexible in the long run, changes in price level do not change firm's real profits and therefore do not change firms level of output. Meaning that LRAS is vertical at the economy's level of full employment.

Short Run Aggregate Supply (SRAS) Because input prices are sticky in the short-run, the SRAS is upward sloping.

An increase in SRAS is seen as a shift to the right. A decrease in SRAS is seen as a shift to the left
The key to understanding shift in SRAS is per unit cost if production
Per unit production cost= total input cost/total output

Determinant of SRAS

• Input prices 
• Domestic resource prices 
• Wages (75% of all business cost)
• Cost of capital
• Raw materials (commodity prices)

Foreign resource prices

• Strong $ = lower foreign resource prices
• Weak $ = higher foreign resource prices

Market power-monopolies and cartels that control rss control the price if those rss

• Increase In resource prices (AS Shift <)
• Decreases In resource prices (AS Shift >)

Productivity

• productivity = total output/ total inputs
• More productivity= lower unit production cost (AS Shift >)
• Lower productivity = higher unit production cost (AS Shift <)

Legal institutions environment (Taxes and subsides)

• taxes ($ to government) on business increase per unit production cost (AS Shift <)
• subsidies ($ from government) to business reduce pet unit production cost (AS Shift >)

Government regulation

• Government regulation created a cost of compliance (AS Shift <)
• Government deregulation reduces compliance costs (AS Shift >)

Unit 3 - Aggregate Demand

February 11, 2015

The aggregate demand shows the amount of real GDP that the private, public and foreign sector collectively desire to purchase at each possible price level. The relationship between the price level and the level of real GDP is inverse.

Three reasons AD is downward sloping

• Real-Balance effect: When the price level is high households and businesses cannot afford to purchase as much output. When the price level is low households and businesses can afford to purchase more output
• Interest-Rate effect: A higher price level increase the interest rate which tends to discourage investment. A lower price level decreases the interest rate which tends to encourage investment.
• Foreign purchases effect: The higher the price level, an increase in demand for relatively cheaper imports.

Shifts in AD

• Two parts to a shift in AD
• A ∆ in C, Ig, G, and/or Xn
• A multiplier effect that produces a greater change than the original ∆ in the 4 components.
• Increase in AD = AD >
• Decrease in AD = AD <

Consumption

• Households spending
• Consumer Wealth: More spending (AD Shifts >)
• Less wealth: Less spending (AD Shifts <)
• Consumer expectations
• Positive Expectations: More spending (AD Shift >)
• Negative Expectations: Less spending (AD Shift <)
• Household indebtedness
• Less debt: More spending (AD Shift >)
• More debt: Less spending (AD Shift <)
• Taxes
• Less taxes: More spending (AD Shift >)
• More taxes: Less spending (AD Shift <)

Gross private investment

• Te real interest rate
• Lower real interest rate: More investment (AD Shift >)
• Higher real interest rate: Less investment (AD Shift <)
• Expected returns
• Higher expected returns: More investment (AD Shift >)
• Lower expected returns: Less investment (AD Shift <)

Government spending

• More government spending (AD Shift >)
• Less government spending (AS Shift <)

Net exports

• Exchange rates (International value of $)
• Strong $ : More Imports and fewer exports (AD Shift <)
• Weak $ : Fewer imports and more exports ( AD Shift >
• Relative income
• Strong Foreign Economies: More exports (AD Shift >)
• Weak Foreign Economies: Less exports (AD Shift <)