Econ final

required reserves

- banks are required by law to keep as reserves 10 percent of their checking account deposits above a certain threshold level

judging how fast economic variables are growing

- calculate the number of years it would take to double - for example: if real GDP per capita in a country doubles, say, every 20 years, most people in the country will experience significant increases in their standard of living over the course of their lives - if real GDP per capita doubles only every 100 years, increases in the standard of living will occur too slowly to notice

information

- collection and communication of it - facts about borrowers and expectations about returns on financial securities

explaining movements in saving, investment, and interest rates

- real interest rate that lenders will receive and that borrowers must pay - we draw the demand curve for loanable funds by holding constant all factors, other than the interest rate, that affect the willingness of borrowers to demand funds - we draw the supply curve by holding constant all factors, other than the interest rate, that affect the willingness of lenders to supply funds

3 main sources of technological change

1. better machinery and equipment: computers, factory machine tools, electric generators 2. increases in human capital: capital refers to physical capital, including computers/factory buildings/tools/warehouses/trucks. The more physical capital workers have available the more output they can produce. Human capital is the accumulated knowledge and skills that workers acquire from education and training or from life experiences 3. better means of organizing and managing production: productivity increases if managers can do a better job of organizing production. The just-in-time system (first developed by Toyota) involves assembling goods from parts that arrive at the factory at exactly the time they are needed. Toyota needs fewer workers in the store and can keep track of parts in the factory so the quantity of goods produced per hour increases. NOTE *** Technological change is not the same thing as more physical capital. Simply adding more capital that is the same as existing capital is not technological change

net exports equal net foreign investment

if a firm's costs are greater than its revenues, it has to make up the difference by selling assets or by borrowing. - a country is in the same situation when it imports more than it exports. The country must finance the difference by selling assets (such as land, office buildings, or factories) or by borrowing

the financial system provides 3 key services for savers and borrowers

1. risk sharing 2. liquidity 3. information

money market mutual funds

mutual fund companies sell shares to investors and use the funds raised by financial assets like stocks and bonds - money market mutual funds: invest in very short-term bonds like US Treasury bills

Irving Fisher was wrong

in asserting that the velocity of money is constant - from year to year there can be significant fluctuations in velocity - as a result the predictions of the quantity theory do not hold every year ** in the long run, inflation results from the money supply growing at a faster rate than real GDP

newly industrializing countries

in the 1980s and 1990s a small group of countries (mostly East Asian countries like Singapore and South Korea) experienced high rates of growth

M1: the narrowest definition of the money supply

includes: 1. currency, which is all the paper money and coins that are in circulation where "in circulation" means not held by banks or the government 2. the value of all checking account deposits at banks 3. the value of travelers' checks (category is small about $4.4 billion)

the use of physical capital like computers or tools ...

is rival because if one firm uses it others cannot and it is excludeable because the firm that owns the capital can keep other firms from using it

when the Fed wants to reduce aggregate demand to reduce inflation ...

it engages in a contractionary monetary policy - the Fed sells Treasury securities to increase interest rates and reduce aggregate demand. - in a closed economy the main effect is once again on domestic investment spending and purchases of consumer durables - in a open economy higher interest rates will lead to a higher foreign exchange value of the dollar. The prices of US products in foreign markets will increase and the prices of foreign products in the US will fall

when the government runs a budget surplus by spending less than it receives in taxes ...

it is saving

private saving equation

equal to what households have left of their income after spending on consumption goods and paying taxes private saving = national income - consumption - taxes S(private) = Y - C - T

public saving

equals the amount of tax revenue the government retains after paying for government purchases and making transfer payments to households S(public) = T - G - TR

financial intermediaries

ex: banks, mutual funds, pension funds and insurance companies, acting as go-betweens for borrowers and lenders

aggregate demand and aggregate supply model

explain short-run fluctuations in real GDP and price level

net capital flows

financial account is a measure of this, or the difference between capital inflows and capital outflows

dissaving

negative saving

19th century

new technologies: steam engine, the railroad and the telegraph also became available

money market mutual funds

funds sell shares to investors and use the money to buy short-term securities such as Treasury bills and commercial paper issued by corporations

crowding out

^^^ by borrowing to finance its budget deficit, the government will have crowded out some firms that would otherwise have been able to borrow to finance investment - crowding out refers to a decline in investment spending as a result of an increase in government purchases

a nonproduced, nonfinancial asset

a copyright, patent, trademark, or right to natural resources

assume economic growth is desirable

assume economic growth is desirable

why do we need money?

by making exchange easier, money allows people to specialize and become more productive

business cycle

during economic expansions, the inflation rate usually increases, particularly near the end of the expansion, and during recessions the inflation rate usually decreases

barter economies

economies where g/s are traded directly for other g/s - problems with barter give societies incentive to identify a product that most people will accept in exchange for what they have to trade

expansion phase

production, employment and income are increasing - the period of expansion ends with a business cycle peak

when the government runs a budget deficit

public saving is negative

the effect of the business cycle on the unemployment rate

recessions cause the inflation rate to fall, but they cause the unemployment rate to increase - as firms see their sales decline they begin to reduce production and lay off workers

financial account

records purchases of assets a country has made abroad and foreign purchases of assets in the country

increases in the quantity of capital per hour worked

result in movements up the per-worker production function, increasing the quantity of output each worker produces - when holding technology constant, equal increases in the amount of capital per hour worked lead to diminishing increases in output per hour worked

public saving equation

saving by the government sector Government saving = Taxes - Government spending or S(public) = T - G

short-run aggregate supply curve

shows the relationship in the short-run between the price level and the quantity of real GDP supplied by firms

what caused the productivity slowdown of 1973 - 1994?

some economists argue that productivity really didn't slow down, it only appears to have slowed down because of problems in measuring productivity accurately - after 1970, services (like haircuts and financial advice) became a larger fraction of GDP and goods (like automobiles and hamburgers) became a smaller fraction. ** it is more difficult to measure increases in the output of services than to measure increases in the output of goods

human capital

the accumulated knowledge and skills workers acquire from education and training or from their life experiences

the effect of the business cycle on inflation rate

the price level measures the average prices of goods and services in the economy and the inflation rate is the percentage increase in the price level from one year to the next year

labor productivity

the quantity of goods and services that can be produced by one worker or by one hour of work

simple deposit multiplier

the ratio of the amount of deposits created by banks to the amount of new reserves 1 / RR change in checking account deposits = change in bank reserves x 1/RR

can conclude that holding constant all other factors ..

there is a lower level of investment spending in the economy when there is a budget deficit when there is a balanced budget

high rates of inflation

very high rates of inflation, in excess of 100 percent per year, are known as hyperinflation - hyperinflation is caused by central banks increasing the money supply at a rate far in excess of the growth rate of real GDP - a high rate of inflation causes money to lose its value so rapidly that households and firms avoid holding it

foreign direct investment

when firms build or buy facilities in foreign countries

foreign portfolio investment

when investors buy stock or bonds issued in another country

bank run

when many depositors simultaneously decide to withdraw their money from a bank

budget surplus

when the government spends less than it collects in taxes - a surplus increases public saving and the total level of saving in the economy

when a government budget deficit leads to a decline in net exports the result is sometimes referred to as twin deficits

which refers to the possibility that a government budget deficit will also lead to a current account deficit.

short-run aggregate supply curve (2)

while the LRAS is vertical, the SRAS curve is upward sloping. As price level increases the quantity of goods/services firms are willing to supply will increase - as prices of final goods and services rise, prices of inputs like the wages of workers or the price of natural resources, rise more slowly. - profits rise when the prices of the goods/services firms sell rise more rapidly than the prices they pay for inputs

money plays a key role in the functioning of an economy by facilitating trade in g/s and by making specialization possible

without specialization no advanced economy can prosper

federal reserve districts

- 12 and was made in 1913 - each district has its own Fed. Reserve bank which provides services to banks in that district - the real power of the Fed is in washington with the Board of Governors

key assets to a bank's balance sheet are..

- reserves - loans - holdings of securities (US treasury bills)

medium of exchange

- sellers are willing to accept it in exchange for goods or services - with a medium of exchange, people can sell goods and services for money and use the money to buy what they want - an economy is more efficient when a single good is recognized as a medium of exchange

how do shifts in demand and supply

1. changes in the demand for US produced goods and services and changes in the demand for foreign-produced g/s 2. changes in the desire to invest in the US and changes in the desire to invest in foreign countries 3. changes in the expectations of currency traders about the likely future value of dollar and the likely future value of foreign currencies

the functions of money

1. medium of exchange 2. unit of account 3. store of value 4. standard of deferred payment

to summarize:

1. when banks gain reserves, they make new loans and the money supply expands 2. when banks lose reserves, they reduce their loans and teh money supply contracts

fall 2008

Fed. Reserve and the US Treasury decided not to take action to save the investment bank Lehman Brothers, which failed - the failure of Lehman Brothers reverberated throughout the financial system, setting off a panic * the well-publicized difficulties of a money market mutual fund that had suffered losses on loans to Lehman Brothers led to a wave of withdrawals from these funds

net worth

a corporation's stockholder's equity is also referred to as its net worth

what Fed also does

acts as a bankers' bank, providing services such as check clearing to banks and also has the responsibility of managing the nation's money supply

shifts of the aggregate demand curve versus movements along it

aggregate demand curve tells us the relationship between the price level and the quantity of real GDP demanded, holding everything else constant - if the price level changes but other variables that affect the willingness of households/firms/the government to spend are unchanged, the economy will move up or down a stationary aggregate demand curve

expansion --- adjustment back to potential GDP in the long run

an automatic mechanism brings the economy back from a short-run equilibrium beyond potential GDP - workers will push for higher wages because each dollar of wages is able to buy fewer g/s and firms will charge higher prices - in addition, the low levels of unemployment resulting from the expansion will make it easier for workers to negotiate for higher wages

shift in the supply of foreign exchange

an economic expansion in the US increases the incomes of Americans and increase their demand for g/s including g/s made in Japan. As US consumers and firms increase their spending on Japanese products they must supply dollars in exchange for yen which causes the supply curve for dollars to shift to the right. - a recession in the US will decrease the demand for Japanese products and cause the supply curve for dollars to shift to the left

poorer countries

developing countries ex: Africa, Asia, and Latin America

changes in the price level

do not affect the number of workers, the capital stock, or technology. so in the long run, changes int he price level do not affect the level of real GDP

the federal government

does not decide when a recession begins or when it ends - most economists accept the decisions of the Business Cycle Dating Committee of the National Bureau of Economics Research (NBER)

growth in potential GDP in the US is estimated to be about 3.3 percent per year

during the 2007 -2009 recession, the gap between actual real GDP and potential GDP was particularly large, which is an indication of how severe the recession was

during the financial crisis of 2007 -2009 the surge in bank holdings of excess reserves reduced the multiplier to about 1

during the financial crisis of 2007 -2009 the surge in bank holdings of excess reserves reduced the multiplier to about 1

shadow banking system

in the past 20 years ... 1. Banks have begun to sell many of their loans rather than keep them until they are paid off 2. financial firms other than commercial banks have become sources of credit to businesses

gap between real GDP and potential GDP

in the recession it caused the unemployment rate to soar to 9.3 percent - the highest unemployment rate since the recession of 1981-82 and the second highest since the Great Depression of the 1930s

what determines the rate of long-run growth?

increases in real GDP per capita depend on increases in labor productivity

high-income countries

industrial companies ex: Western Europe, Australia, Canada, Japan, New Zealand, and US

capital inflow

into the US when a foreign investor buys a bond issued by a US firm or by the government or when a foreign firm builds a factory in the US

securitization

involves creating a secondary market in which loans that have been bundled together can be bought and sold in financial markets

inflation rate = growth rate of the money supply - growth rate of real output

leads to following predictions: 1. if the money supply grows at a faster rate than real GDP there will be inflation 2. if the money supply grows at a slower rate than real GDP there will be deflation 3. if the money supply grows at the same rate as real GDP, the price level will be stable and there will be neither inflation nor deflation

potential GDP

level of real GDP attained when all firms are producing at capacity - the capacity of a firm is not the maximum output the firm is capable of producing but is instead measured by its production when operating on normal hours using a normal workforce

potential GDP or full-employment GDP

level of real GDP in the long run - at potential GDP, firms will operative at their normal level of capacity and everyone who wants a job will have one, except the structurally and frictionally unemployed

in an open economy

lower interest rates will also affect the exchange rate between the dollar and foreign currencies.

the financial crisis of 2007 - 09

problems in the housing market were bade news for workers and firms involved with residential construction - an increased number of borrowers defaulted on mortgage loans. These defaults caused banks and some other financial institutions to suffer heavy losses - led to a "credit crunch" that made it difficult for many households and firms to obtain the loans they needed to finance their spending

mutual funds

sell shares to savers and then use the funds to buy a portfolio of stocks, bonds, mortgages and other financial securities

some exchange rates are not determined by the market

some currencies have fixed exchange rates that do not change over long periods

secondary market

subsequent sales take place in the secondary market - prior 1970 most loans were not securities because they could not be resold (there was no secondary market)

velocity of money

the average number of times each dollar of the money supply is used to purchase goods and services included in GDP V = (P x Y) / M *** use M1 to measure M

net exports equals the sum of the balance of trade and the balance of services

the balance of services is the difference between the value of the services a country exports and the value of the services a country imports

real GDP per capita

the best measure of a country's standard of living because it represents the ability of the average person to buy goods / services

risk

the chance that the value of a financial security will change relative to what you expect ex: Most indiv. savers are not gamblers and seek a steady return on their savings rather than erratic swings between high and low earnings. The financial system provides risk sharing by allowing savers to spread their money among many financial investments ( you can divide your money among a bank certificate of deposit, indiv bonds and a mutual bond)

supply curve for loanable funds is upward sloping

the higher the interest rate, the greater the quantity of saving supplied

because banks specialize in fathering information on borrowers ...

they are able to do it faster and at a lower cost than can individual savers

supply shock -- adjustment back to potential GDP in the long run

this eventually results in workers being willing to accept lower wages and firms being willing to accept lower prices

balanced budget

when the government spends the same amount that it collects in taxes there is a balanced budget

balance of payments

which is a record of a country's trade with other countries in goods, services and assets

how the government can fight inflation

- a contractionary fiscal policy to slow the growth of aggregate demand - a contractionary fiscal policy cuts government purchases or raises taxes to reduce household disposable income and consumption spending - it also reduces the federal budget deficit (or increases the budget surplus) which may lower interest rates - lower interest rates will increase domestic investment and purchases of consumer durables thereby offsetting some of the reduction in government spending fiscal policy has a smaller effect on aggregate demand in an open economy than in a closed economy

economic growth from 1,000,000 B.C. to Present

- a peasant toiling on a farm in France in the year 1300 was no better off than his ancestors thousands of years before - for most of human existence, the typical person had only the bare minimum of food/clothing/shelter necessary to sustain life - few people survive beyond age 40 and most people suffered from illnesses

before 1980 US law prohibited banks from paying interest on checking account deposits

- almost all currency, checking account deposits, and travelers' checks were held with the intention of buying and selling, not with the intention of storing value - in 1980 the law was changed to allow banks to pay interest on certain types of checking accounts

how writers for papers or magazines define a recession

- as having 3 consecutive quarters of declining real GDP, the NBER has a broader definition (a recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income and wholesale - retail trade.)

the end of the housing bubble

- as interest rates on mortgage loans declined, more consumers began to buy new homes - a bubble occurs when people become less concerned with the underlying value of an asset, either a physical asset, such as a house, or a financial asset, such as stock, and focus instead on expectations of the price of the asset increasing - many homes were purchased by investors who intended to resell them for higher prices than they paid for them and did not intend to live in them ("flip" homes)

Romer argues that the accumulation of knowledge capital is a key determinant of growth

- firms add to an economy's stock of knowledge capital when they engage in research and development or otherwise contribute to technological change - increases in capital per hour worked lead to increases in real GDP per hour worked but at a decreasing rate (Romer argues that the same is true of knowledge capital at the firm level ... as firms add to their stock of knowledge capital they increase their output but at a decreasing rate. But Romer argues that at the entire economy level knowledge capital is subject to increasing returns because knowledge once discovered becomes available to everyone)

crowding out effect in an open economy

- higher investment spending will also lead to an increase in foreign exchange value oft eh dollar and decrease in net exports - an expansionary fiscal policy may be less effective because the crowding out effect would be larger - while in a closed economy only consumption and investment are crowded out by an expansionary fiscal policy ... in an open net exports can also be crowded out

balance of payments is always zero

- if the sum of the current account balance and the financial account balance does not equal zero, some imports or exports of goods and services or some capital inflows or capital outflows were not measured correctly

usual cause of inflation

- if total spending in the economy grows faster than total production, prices rise - anticipated increase in prices offsets some of the technological change and increases in the labor force and capital stock that occur during the year - a shift to the left of the short-run aggregate supply curve can also cause an increase in the price level (supply shocks)

unit of account

- in a barter system each good has many prices - a cow may be worth 2 plows, 20 bushels of wheat or 6 axes - once a single good is used as money each good has a single price rather than many prices - the function of money gives buyers and sellers a unit of account (a way of measuring value in an economy)

examples of an increase in....

- interest rates: AD curve to the left - government purchases: AD curve to the right - personal income taxes or business taxes: AD curve to the left - households' expectations of their future incomes: AD curve to the right - firms' expectations of the future profitability of investment spending: AD curve to the right - the growth rate of domestic GDP relative to the growth rate of foreign GDP: AD curve to the left - the exchange rate (US) relative to foreign currencies: AD curve to the left

fiat money

- paper currency has no value unless it is used as money and it is therefore not a commodity money. Instead it is fiat which means it has no value except as money problem ... what if you had to transport bars of gold to settle your transactions? not only would doing so be difficult and costly but you would run the risk of being robbed to avoid ^^ private institutions or governments began to store gold and issue paper certificates that could be redeemed for gold.

Can create a dynamic aggregate demand and aggregate supply model by making changes to the basic model

- potential real GDP increases continually, shifting the long-run aggregate supply curve to the right - during most years, the aggregate demand curve shifts to the right - except during periods when workers and firms expect high rates of inflation, the short-run aggregate supply curve shifts to the right

recession --- short-run effect of a decline in AD

- rising interest rates cause firms to reduce spending on factories and equipment and cause households to reduce spending on new homes - the decline in investment that results will shift the aggregate demand curve to the left from AD1 to AD2 - the economy moves from point A to a new short-run macroeconomic-equilibrium where AD2 curve intersects with the SRAS 1 curve at point B - this lower level of GDP will result in declining profitability for many firms and layoffs for some workers

long-run aggregate supply curve shifts to the right

- shift occurs because during the year, potential real GDP increases as the US labor force and the US capital stock increase and technological progress occurs

supply shock -- short-run effect

- suppose oil prices increase substantially, the supply shock will increase many firms' costs and cause the SRAS curve to shift to the left - ^^ this makes the price level higher in the SRAS but real GDP lower - stagflation: a combination of inflation and recession, usually resulting from a supply shock

technological change helps economies avoid diminishing returns to capital

- suppose the layout of your store can be improved, maybe the paper for the machines is on shelves at the back of the store which requires your workers to spend time walking back and forth whenever the machines run out of paper. By placing the paper closer to the copy machines you can improve the productivity of your workers

examples of what happens to SRAS with an increase in...

- the labor force or the capital stock: SRAS curve to the right - productivity: SRAS curve to the right - expected future price level: SRAS curve to the left - workers and firms adjusting to having previously underestimated the price level: SRAS curve to the left - the expected price of an important natural resource: SRAS curve to the left

closed economy

- there is no trading or borrowing and lending with other economies - net exports are zero (Y = C + I + G) or (I = Y - C - G) which tells us that in a closed economy, investment spending is equal to total income minus consumption spending and minus government purchases

central bank

- this issues the paper currency - is an agency of the government that regulates money supply - Federal Reserve is the central bank of the US

commodity money

- value independent of its use as money - Gold, for example, was a common form of money in the 19th century - commodity money has problems (depends on its purity, therefore someone who wanted to cheat could mix impure metals with precious metal.... and using gold as money meant the money supply was difficult to control because it depended partly on unpredictable discoveries of new gold fields)

security

- when a bank made a residential mortgage loan to a households to buy a home or made a commercial loan to business, the bank would keep the loan and collect the payments until the loan was paid off. - A financial asset such as loan or a stock or bond is considered a security if it can be bought and sold in financial market

interest rate effect: how a change in the price level affects investment

- when prices rise, households and firms need more money to finance buying and selling - households and firms will try to increase the amount of money they hold by withdrawing funds from banks, borrowing from banks or selling financial assets like bonds. - these actions tend to drive up the interest rate charged on bank loans and the interest rate on bonds - a higher interest rate raises the cost of borrowing for firms and households. As a result, firms will borrow less to build new factories or to install new machinery and equipment because a higher price level increases the interest rate and reduces investment spending, it also reduces the quantity of goods and services demanded - a lower price level will decrease the interest rate and increase investment spending, thereby increasing the quantity of goods and services demanded - it is a second reason the aggregate demand curve is downward sloping

3 monetary policy rules the Fed uses

1. Open market operations 2. discount policy 3. reserve requirements

variables that shift the aggregate demand curve (1)

1. changes in government policies - monetary policy: involves actions the Fe. Reserve (nation's central bank) takes to manage the money supply and interest rates and to ensure the flow of funds from lenders to borrowers. To attain macroeconomic policy objectives like high employment/price stability/high rates of economic growth. - ex: by lowering interest rates, the Fed. Reserve can lower the cost to firms and households of borrowing. Lowering borrowing costs increases consumption and investment spending which shifts the AD curve to the right - fiscal policy: involves changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives. Because the government purchases are one component of AD, an increase in government purchases shifts the AD curve to the right.

how not predicting price level results in an upward sloping SRAS curve

1. contracts make some wages and prices "sticky" - prices or wages are said to be sticky when they do not respond quickly to changes in demand or supply - a steel mill might have signed a multi-year contract to buy coal, which is used in making steel, at a time when the demand for steel was stagnant. If steel demand and steel prices begin to rise rapidly, producing additional steel will be profitable because coal prices will remain fixed by contract - if the managers of the coal companies had accurately predicted that would happen to prices the steel mill would have earned greater profits when prices rose 2. firms are often slow to adjust wages: many nonunion workers also have their wages or salaries adjusted only once a year - if firms are slow to adjust wages, a rise in the price level will increase the profitability of hiring more workers and producing more output. A fall in the price level will decrease the profitability of hiring more workers and producing more output. - firms are often slower to cut wages than to increase them. Cutting wages can have a negative effect on the morale and productivity of workers and can also cause some of a firm's best workers to quit and look for jobs elsewhere 3. menu costs make some prices sticky: firms base their prices today partly on what they expect future prices to be. For instance, before it prints menus, a restaurant has to decide the prices it will charge for meals. (many firms also print catalogs) - changing prices would be costly because it would involve printing new menus or catalogs. The costs to firms of changing prices are menu costs. - consider the effect of an unexpected increase in the price level. In this case, firms will want to increase the prices they charge. Some firms may not be willing to increase prices because of menu costs. Because of their relatively low prices, these firms will find their sales increasing which will cause them to increase output

why don't more low-income countries experience rapid growth?

1. failure to enforce the rule of law: countries have abandoned centrally planned economies in favor of more market-oriented economies. For entrepreneurs in a market economy to succeed, the government must guarantee private property rights and enforce contracts. Unless entrepreneurs feel secure in their property, they will not risk starting a business. - the rule of law: refers to the ability of a government to enforce the laws of the country, particularly with respect to protecting private property and enforcing contracts - many developing countries do not have functioning, independent court systems and even if one does exist a case may not be heard for many years (political favoritism and bribery of judges) 2. wars and revolutions: have experienced extended periods of war or violent changes of government - ex: Afghanistan, Angola, Ethiopia, the Central African Republic and the Congo 3. poor public education and health: many low-income countries have weak public school systems so many workers are unable to read and write. Few workers acquire the skills necessary to use the latest technology - many low-income countries suffer from diseases that are either nonexistent or treated readily in high-income countries - people who are sick work less and are less productive when they do work 4. low rates of saving and investment: in most developing countries stock and bond markets do not exist and often the banking system is very weak. In high-income countries the funds that banks lend to businesses come from the savings of households. In developing countries many households barely survive on their incomes and therefore have little/no savings

variables that shift the short-run aggregate supply curve

1. increases in the labor force and in the capital stock: a firm will supply more output at every price if it has more workers and more physical capital. (In Japan, the population is aging, and the labor force is decreasing. Holding other variables constant, this decrease in the labor force causes the short-run aggregate supply curve in Japan to shift to the left.) 2. technological change: the productivity of workers and machinery increases, which means firms can produce more goods and services with the same amount of labor and machinery. This reduces the firms' costs of production allowing them to produce more at every price level. 3. expected changes in the future price level: if workers and firms believe that the price level is going to increase by 3 percent during the next year, they will try to adjust their wages and prices accordingly. In general, if workers and firms expect the price level to increase by a certain percentage, the SRAS curve will shift by an equivalent amount, holding constant all other variables that affect the SRAS curve 4. adjustments of workers and firms to errors in past expectations about the price level: workers and firms sometimes make incorrect predictions about the price level. As time passes they will attempt to compensate for these errors 5. unexpected changes in the price of an important natural resource: an unexpected event that causes the short-run aggregate supply curve to shift is known as a supply shock. - supply shocks are often caused by an unexpected increases or decreases in the prices of important natural resources that can cause firms' costs to be different from what they had expected. Oil prices are a good example. - oil. Some utilities also burn oil to generate electricity, so electricity prices will rise. Rising oil prices lead to rising gasoline prices, which raise transportation costs for many firms. - because the US economy ha experienced at least some inflation every since since the 1930s, workers and firms always expect next year's price level to be higher than this year's price level. Holding everything else constant, expectations of a higher price level will cause the SRAS curve to shift to the left.

government policy helping increase the accumulation of knowledge capital

1. protecting intellectual property with patents and copyrights: gives an incentive to engage - patents (gives a firm the exclusive legal right to a new product for a period for 20 years from the date the patent was applied for) - the patent system has drawbacks: in filing for a patent, a firm must disclose information about the product or process. This information enters the public record and may help competing firms develop products or processes that are similar but that do not infringe on the patent ^^ to avoid this problem a firm may try to keep the results of its research a trade secret without patenting it (famous example = formula for Coca-Cola) - a product receives a patent protection, books, films and other artistic works receive copyright protection (under US law the creator of a book/film has the exclusive right to use the creation during the creator's lifetime, the heirs retain this exclusive right for 70 years after the creator's death) 2. subsidizing research and development: government conducts some research directly, the government also subsidizes research by providing grants to researchers in universities through the National Science Foundation and other agencies. Government also provides tax benefits to firms that invest in research and development 3. subsidizing education: if firms are unable to capture all the profits from research and development, they will pay lower wages and salaries to technical workers. These lower wages and salaries reduce the incentive to workers to receive this training. - if the government subsidizes education, it can increase the number of workers who have technical training - in US, provides free education from grades kindergarten through 12 and by providing support for public colleges and universities (also has student loans at reduced interest rates)

reason Fed conducts monetary policy through open market operations

1. the Fed initiates open market operations and completely controls their volume 2. Fed can make both large and small open market operations 3. Fed can implement its open market operations quickly with no administrative delay or required changes in regulations

assumptions with recessions, expansions and supply shocks

1. the economy has not been experiencing any inflation. The price level is currently 100 and workers and firms expect it to remain at 100 in the future 2. the economy is not experiencing any long-run growth. Potential real GDP is $14 trillion and will remain at that level in the future - these assumptions are simplifications because in reality, the US economy has experienced at least some inflation every year since the 1930s and the potential real GDP also increases every year

criteria for a medium of exchange

1. the good must be acceptable to (useable) by most people 2. it should be of standardized quality so that any two units are identical 3. it should be durable so that value is not lost by spoilage 4. it should be valuable relative to its weight so that amounts large enough to be useful in trade can be easily transported 5. the medium of exchange should be divisible because different goods are valued differently

several explanations for why the US economy experienced a period of relative stability from 1950 to 2007

1. the increasing importance of services and the declining importance of goods: manufacturing production, particularly production of durable goods such as automobiles, fluctuates more than the production of services. Because durable goods are usually more expensive than services, during a recession households will cut back more on purchases of durables than they will on purchases of services 2. the establishment of unemployment insurance and other government transfer programs that provide funds to the unemployed: programs make it possible for workers who lose their jobs during recessions to have higher incomes and therefore spend more than they would otherwise 3. active federal government policies to stabilize the economy: Because the Great Depression was so severe public opinion began favoring government attempts to stabilize the economy 4. increased stability of the financial system: more than 5,000 banks failed between 1929 and 1933, reducing the savings of many households and firms to obtain the credit needed to maintain their spending. In addition, a decline of more than 80 percent in stock prices greatly reduced the wealth of many households and made it difficult for firms to raise funds by selling stock

money supply

1. the money supply consists of both currency and checking account deposits 2. because balances in checking account deposits are included in the money supply, banks play an important role in the way the money supply increases and decreases

aggregate demand and aggregate supply model assumptions

2 assumptions: 1. the economy does not experience continuing inflation 2. the economy does not experience long-run growth Result: a model that takes into account that the economy is not static, with an unchanging level of potential real GDP and no continuing inflation, but dynamic, with potential real GDP that rows over time and inflation that continues every year.

why have other high-income countries had trouble completely closing the gap in real GDP per capita with the US?

2 explanations: 1. greater flexibility of US labor markets 2. greater efficiency of of US financial system - in many European countries, government regulations make it difficult for firms to fire workers and thereby make firms reluctant to hire workers in the first place ... also restrictions on implementing new technologies - in the US government regulations are less restrictive and workers have an easier time finding jobs/change jobs frequently (high rate of job mobility ensures a better match between workers' skills and preferences and the job so productivity increases)

the market exchange rate is determined by the interaction of demand and supply, just as other prices are

3 sources of foreign currency demand for the US dollar 1. foreign firms and households that want to buy g/s produced in the US 2. Foreign firms and households that want to invest in the US either through foreign direct investment (buying or building factories or other facilities in the US) or through foreign portfolio investment (buying stocks/bonds issued in the US) 3. currency traders who believe that the value of the dollar in the future will be greater than its value today

board of governors

7 members appointed by the president of the US to 14-year, nonrenewable terms

open market operations

8 times per year the Federal Open Market Committee (FOMC) meets in DC to discuss monetary policy - the US Treasury borrows money by selling bills, notes and bonds. The maturity of a financial asset is the period of time until the purchaser receives payment of the face value or principal - to increase the money supply, the FOMC directs the trading desk to buy US Treasury securities from the public. When the sellers of the Treasury securities deposit the funds in their banks, the reserves of the banks rise. The increase in reserves starts the process of increasing loans and checking account deposits that increases the money supply. To decrease the money supply the FOMC directs the trading desk to sell Treasury securities Open Market Operations: buying and selling of Treasury securities

lender of last resort

A central bank like the Reserve can help stop a bank panic by acting as a lender of last resort - a central bank makes loans to banks that cannot borrow funds elsewhere. The banks can use these loans to pay off depositors. When the panic ends and the depositors put their money back in their accounts, the banks can repay the loans to the central bank

Quantity Theory of Money

Irving Fisher, an economist at Yale made this quantity equation M x V = P x Y the quantity equation states that the money supply (M) multiplied by the velocity of money (V) equals the price level (P) multiplied by real output (Y)

cpi (salary crap)

Presidential Obama's Salary ::: President Truman's Salary - Obama's: $400,000 in 2012 - Truman's: $75,000 in 1950 - looks like Obama made more, but in 2012 things are more expensive than in 1950 - can transfer Obama's salary to amount in 1950 dollars, then compare it to Truman's - 40,000 x (CPI in 1950 / CPI in 2012) = 40,000 x (24/230) = $41,739 ^ looked up those CPI numbers online - got paid more in 1950 because $75,000 salary is greater than what Obama's would have been

national saving = private saving + public saving

S = S(private) + S(public)

total saving in the economy

S = S(private) + S(public) or S = Y - C - G the right side of this expression is identical to the expression we derived earlier for investment spending so we can also conclude S = I

Timothy Geithner

Treasury secretary in the Obama administration, referred to investment banks, money market mutual funds, hedge funds and other financial firms engaged in similar activities as the shadow banking system

discount policy

a bank borrows money from the Fed by taking out a discount loan, the interest rate the bank pays is known as the discount rate - by lowering the discount rate the Fed can encourage banks to take additional loans and increase their reserves. With more reserves, banks will make more loans to h/firms which will increase checking account deposits and the money supply

in the long run...

a country will experience an increasing standard of living only if it experiences continuing technological change

commodity money

a good used as money that also has value independent of its use as money - historically, once a good became widely accepted as money, people who did not have an immediate use for it would be willing to accept it

a firm that operates entirely within the US will price its products in dollars and will use dollars to pay its suppliers' bills, wages and salaries to its workers, interest to its bondholders and dividends to its shareholders.

a multinational corporation such as McDonald's in contrast may sell its products in many different countries and receive payments in many different currencies

quantity theory of money explained

a theory is a statement about the world that might possibly be false. Therefore, the quantity equation is not a theory. Irving Fisher turned the quantity equation to a theory by asserting that velocity was constant. - he argued that the average number of times a dollar is spent depends on how often people get paid, how often they do their grocery shopping, how often businesses mail bills and other factors that do not change very often

acceptance that households and firms have confidence that if they accept paper dollars in exchange for goods and services the dollars will not lose much value during the time they hold them

acceptance that households and firms have confidence that if they accept paper dollars in exchange for goods and services the dollars will not lose much value during the time they hold them

checking account deposits versus currency

account deposits are used much more often than currency to make payments - more than 80 percent of all expenditures on g/s are made with checks rather than with currency

how accurate is measuring inflation based on the quantity theory?

accuracy depends on whether the key assumption that velocity is constant is correct - because velocity can move erratically in the short run, we would not expect the quantity equation to provide good forecasts of inflation in the short run (over the long run there is a strong link)

what caused the productivity slowdown of 1973 - 1994? (NUMBER 2)

also may be a measurement problem in accounting for improvements in the environment and in health and safety - new laws required firms to spend billions of dollars reducing pollution, improving workplace safety, and redesigning products to improve their safety. - this spending did not result in additional output that would be included in GDP although it may have increased well-being

why growth rates matter

an economy that grows too slowly fails to raise living standards - although their problems are less dramatic, countries that experience slow growth have also missed opportunities to improve the lives of their citizens. ex: failure of Argentina to grow as rapidly as the other countries it had similar levels of GDP per capita in 1950 left many of its people in poverty (life expectancy was lower than high-income countries)

real exchange rate

an important factor in determining the level of a country's exports to and imports from another country is the relative prices of each country's goods - prices of 2 countries' goods are determined by 2 factors: the relative price levels in the 2 countries and the nominal exchange rate between the 2 currencies. - economists combine these 2 factors in the real exchange rate which is the price of domestic goods in terms of foreign goods. real exchange rate = nominal exchange rate x (domestic price level / foreign price level).

If, for example, the profitability of new investment increases due to technological change, firms will increase their demand for loanable funds

an increase in the quantity of loanable funds means that both the quantity of saving by households and the quantity of investment by firms have increased - increasing investment increases the capital stock and the quantity of capital per hour worked, helping to increase economic growth

money

any asset that people are generally willing to accept in exchange for goods and services or for payment of debts

excess reserves

any reserves that banks hold over and above the legal requirement

assets

anything of value owned by a person or a firm

entrepreneurs

are important for implementing technological change - in a market economy they make the crucial decisions about whether to introduce new technology to produce better or lower-cost products, and decide whether to allocate a firm's resources to research and development resulting in new technologies

a recession will often begin with a decline in spending by firms on capital goods (machinery, equipment, new factories, office buildings ... or by households on new homes and consumer durables like furniture and automobiles)

as spending declines, firms selling capital goods and consumer durables will find their sales declining. - as sales decline, firms cut back on production and begin to lay off workers - rising unemployment and falling profits reduce income, which leads to further declines in spending - toward the end of a recession, household and firms begin to reduce their debt, thereby increasing their ability to spend and interest rates decline making it more likely that households and firms will borrow to finance new spending

aggregate demand curve shifts to the right

as the population grows and incomes rise, consumption will increase over time. - as the economy grows, firms will expand capacity and new firms will be formed, increasing investment - an increasing population requires an increase in government services like more police officers and teachers so government purchases will rise changes in the price level and in real GDP in the short run are determined by shifts in the SRAS and AD curve

why an increase in reserves in the banking system leads to the creation of new deposits and therefore an increase in the money supply

assume: banks do not keep any excess reserves. ex: when you deposited $1,000 in currency into your checking account at Bank of America, it loaned out $900, keeping only the $100 for required reserves the more excess reserves banks keep the smaller the deposit multiplier assume:that the whole amount of every check is deposited in a bank, no one takes any of it out as currency - would expect to see people increasing the amount of currency they hold as the balances in their checking accounts rise. ex: Suppose that when Bank of America makes the initial $900 loan to the borrower who wants to buy a used car, the seller of the car cashes the check instead of depositing it. In that case PNC does not receive any new reserves and does not make any new loans

loans

banks make consumer loans to households and commercial loans to businesses - a loan is an asset to a bank because it represents a promise by the person taking out the loan to make certain specified payments to the bank

why the AD curve is downsloping

because a fall in the price level increases the quantity of real GDP demanded - assume that government purchases are determined by the policy decisions of lawmakers and are not affected by changes in the price level to consider the effect of changes in the price level on consumption, investment and net exports

when imports are greater than exports, net exports are negative and there will be a net capital inflow as people in the US sell assets and borrow to pay for the surplus of imports over exports

because net exports are usually negative for the US, in most years, the US must be a net borrower from abroad, US net foreign investment will be negative

Joseph Schumpeter

born in Austria in 1883 - served briefly as finance minister - professor at Harvard according to him, the key to raising living standards is not small changes to existing products but rather new products that meet consumer wants in qualitatively better ways - ex: in the early 20th century, the automobile displaced the horse-drawn carriage by meeting consumer demand for personal transportation to Schumpeter: the entrepreneur is central to economic growth

long-run economic growth

brought the typical american from the standard of living of 1900 to the standard of living of today - best measure of the standard of living is real GDP per person, usually referred to as real GDP per capita - measure long-run economic growth by increases in real GDP per capita over long periods of time, generally decades or more

impact of faster data processing

business record keeping, once done by hand, is now done more quickly and accurately by computer - increase use of Internet brought changes to the ways firms sell to consumers and to each other. - cell phones, laptops, and wireless internet allow people to work away from the office (at home and while traveling) ^^ all increase productivity

smell-denomination time deposits are similar to savings accounts

but the deposits are for a fixed period of time (usually from 6 months to several years) and withdrawls before that time are subject to penalty

** Fed is responsible for putting the paper currency into circulation

but the main way the Fed increases the money supply is not by printing more currency... instead by buying Treasury securities to reduce money supply Fed does not burn paper money but sells Treasury securities

free ride on knowledge capital

can do this because knowledge capital is nonrival and nonexcludable - Romer says firms are unlikely to invest in research and development up to the point where the marginal cost of the research equals the marginal return from the knowledge gained because other firms gain much of the marginal return

increases in capital per hour worked

capital refers to manufactured goods that are used to produce other goods and services - ex: computers, factory buildings, machine tools, warehouses and trucks total amount of physical capital available in a country is known as the country's capital stock - as the amount of capital stock per hour worked increases, worker productivity increases

the economic growth model predicts that poor countries will grow faster than rich countries

catch-up: the prediction that the level of GDP per capita (or income per capita) in poor countries will grow faster than rich this catch-up is also called convergence

variables that shift the aggregate demand curve (3)

changes in foreign variables: if firms and households in other countries buy fewer US goods or if firms and households in the US buy more foreign goods, net exports will fall and the AD curve will shift to the left - net exports will also fall if the exchange rate between the dollar and foreign countries rises because the price in foreign currency of US products sold in other countries will rise and the dollar price of foreign products sold in the US will fall - a change in net exports that results from a change in the price level in the US will result in a movement along the AD curve, not a shift of the AD curve

variables that shift the aggregate demand curve (2)

changes in the expectations of households and firms: if households become more optimistic about their future incomes, they are likely to increase their current consumption. - the increased consumption will shift the aggregate demand curve to the right

current account balance + financial account balance = 0 current account balance = -financial account balance net exports = net foreign investment

countries such as the US that import more than they export must borrow more from abroad than they lend abroad: if net exports are negative, net foreign investment will also be negative by the same amount

speculators

currency traders who buy and sell foreign exchange in an attempt to profit from changes in exchange rates

the wealth effect: how a change in the price level affects consumption

current income is the most important variable determining the consumption of households - a household's wealth is the difference between the value of its assets and the value of its debts - some household wealth is held in cash or other nominal assets that lose value as the price level rises and gain value as the price level falls - when the price level rises, the real value of household wealth declines, and so will cosumption, thereby reducing the demand for g/s - this effect of the price level on consumption is called the wealth effect and it is one reason the aggregate demand curve is downward sloping

these curves apply to the whole economy rather than to just a single market

deals with macroeconomic explanations of why aggregate demand curve is downward sloping and why the short-run aggregate supply curve is upward sloping

what the value of money depends on..

depends on its purchasing power - purchasing power: the ability to buy g/s - inflation causes a decline in purchasing power because with rising prices, a given amount of money can purchase fewer g/s

reserves

deposits that a bank has retained rather than loaned out or invested - banks keep reserves either physically within the bank as vault cash or on deposit with the Fed. Res.

new growth theory

developed by Paul Romer (economist at Standford) to provide a better explanation of the sources of productivity change - argues that the rate of technological change is influenced by how individuals and firms respond to economic incentives

governments often want to spend more than they are able to raise through taxes

developed countries such as the US can usually bridge gaps between spending and taxes by borrowing through selling bonds to the public - developing countries like Zimbabwe have difficult selling bonds because investors are skeptical of their ability to pay back the money

globalization

developing countries began to change policies in 1980s - refers to the process of countries becoming more open to foreign trade and investment

shifts in the demand for foreign exchange

during an economic expansion in Japan, the incomes of Japanese households will rise, and the demand by Japanese consumers and firms for US goods will increase - the demand curve will shift to the right because incomes rise. Similarly if interest rates in the US rise, the desirability of investing in US financial assets will increase, and the demand curve for dollars will also shift to the right. During a recession: incomes will fall and reduce the demand for US produced g/s and shifting the demand curve for dollars to the left. If interest rates in the US fall the desirability of investing in US financial assets will decrease and the demand curve will shift to the left.

liquidity ... why people hold money

ease with which an asset can be converted into the medium of exchange

technological change

economic growth depends more on technological change than on increases in capital per hour worked - technology: the processes a firm uses to turn inputs into outputs of goods and services - technological change: an increase in the quantity of output firms can produce, using a given quantity of inputs ex: a firm's managers may rearrange a factory floor or the layout of a retailed store to increase production and sales (most change however comes with new machinery, equipment or software)

policy channels

economists refer to the ways in which monetary policy and fiscal policy affect the domestic economy

net foreign investment

equal to capital outflows minus capital inflows. Net capital flows and net foreign investment are always equal but have opposite signs: when net capital flows are positive, net foreign investment is negative - net foreign investment is also equal to net foreign direct investment plus net foreign portfolio investment

private saving

equal to what households retain of their income after purchasing goods and services (C) and paying taxes (t) - households receive income for supplying the factors of production to firms = Y - households also receive income from the government in the form of transfer payments (TR) - ex: Social Security payments and unemployment insurance payments S(private) = Y + TR - C - T

law of diminishing returns: states that as we add more of one input, like capital, to a fixed quantity of another input, like labor, output increases by smaller additional amounts

ex: increasing capital per hour worked from $20,000 to $30,000 increases real GDP per hour worked from $200 to $300, an increase of $150. Another $10,000 increase in capital per hour worked from $30,000 to $40,000 increases real GDP per hour worked from $350 to $475, an increase of only $125

economic growth model

explains growth rates in real GDP per capita over the long run

stocks

financial securities that represent partial ownership of a firm - if you buy one share of stock in General Electric, you become one of millions of owners of that firm

bonds

financial securities that represent promises to repay a fixed amount of funds. - when General Electric sells a bond, the firm promises to pay the purchaser of the bond an interest payment each year for the term of the bond, as well as a final payment of the amount of the loan

firms raise funds by selling financial securities directly to savers

financial securities: a document, sometimes in electronic form, that states the terms under which funds pass from teh buyer of the security, who is providing the funds, to the seller

is the "Great Moderation" over?

fluctuations since the mid-1980s have been particularly mild - by the early 21st century, some economists had begun referring to the absence of severe recessions in the US as the "Great Moderation" - however economists began questioning this view with the recession in Dec. 2007 - this recession was the longest and most severe since the Great Depression of the 1930s and was referred to as the Great Contraction - the recession of 2007 -09 is an exception to the experience of relatively short and mild recessions... this was lasting 18 months (the longest of the post-1950 period)

recession phase

following the period of expansion, production, employment and income decline - comes to end at the business cycle trough, after which another period of expansion begins

who holds these dollars outside the US?

foreign banks and foreign governments hold some dollars, but most are held by households and firms in countries where there is not much confidence in the local currency - when inflation rates are very high, many households/firms do not want to hold their domestic currency because it is losing its value too rapidly. THe value of the US dolalr will be much more stable than their own currency ex: when inflation soared in Zimbabwe, the government was led to adopt the US dollar as the country's official currency

nondurables

goods that are expected to last for fewer than 3 years - consumer nondurables include goods such as food and clothing - durables are affected more by business cycle than are nondurables

durables

goods that are expected to last for three or more years - consumer durables include furniture, appliances, and automobiles - producer durables include machine tools, electric generators, and commercial airplanes

also needed for economic growth..

government must provide secure rights to private property

closed economy

has no interactions in trade or finance with other countries - no economy today is completely closed although a few countries like North Korea have very limited economic interactions with other countries

bank panic

if many banks experience runs at the same time

S - I = NFI

if net foreign investment is negative (as it is for the US every year) domestic investment (I) must be greater than national saving (S)

double coincidence of wants

if the neighbor did not want the plow the trade would not happen. for a barter trade to take place between two people each person must want what the other one has

M2: a broader definition of money

includes everything that is in M1 plus savings account deposits, small denomination time deposits (such as certificates of deposits or CDs... balances in money market deposit accounts in banks) and noninstitutional money market fund shares

as the economy nears the end of an expansion...

interest rates are usually rising and the wages of workers are usually rising faster than prices - as a result of rising interest rates and rising wages, the profits of firms will be falling - typically, toward the end of an expansion, both households and firms will have substantially increased their debts - these debts are the result of the borrowing that firms and households undertake to help finance their spending during expansion

mortgage-backed securities

investment banks, such as Goldman Sachs and Morgan Stanley, differ from commercial banks in that they do not accept deposits and they rarely lend directly to households - instead, they traditionally are concentrated on providing advice to firms issuing stocks and bonds or considering mergers from other firm mortgage-backed securities are bundled together and resold to investors. they proved very popular with investors because they often paid higher interest rates than other securities with comparable default risk

Higher interest rates on financial assets in the US will attract foreign investors

investors in Canada, Japan or China will have to buy US dollars to be able to purchase bonds in the US - this greater demand for dollars will increase their value relative to foreign currencies. - as the value of the dollar rises, exports from the US will fall and imports to the US will rise. - net exports (therefore net foreign investment) will fall

bank's largest liability

is its deposits (include checking accounts, savings accounts, and certificates of deposit) - deposits are liabilities to banks because they are owed to the households or firms that have deposited the funds

the use of knowledge capital like a chemical formula for a drug ...

is nonrival because one firm's using that knowledge does not prevent another firm from using it. it is also nonexcludeable because once something like a chemical formula becomes known, it becomes widely available for other firms to use

banks and other financial institutions around the world employ currency traders

linked together by computer. Rather than exchange large amounts of paper currency they buy and sell deposits in banks.

compounding

magnifies small differences in interest rates over long periods of time - ex: Over a period of 50 years, your $100 would grow to $312 at an interest rate of 2.3 percent but only to $191 at an interest rate of 1.3 percent

expansion --- short-run effect of an increase in aggregate demand

many firms become optimistic about the future profitability of new investment as happened during the information technology and telecommunications booms of the late 1990s - increase in investment will shift the AD curve to the right

what about credit cards and debit cards

many people buy g/s with cc yet cc are not included in definitions of the money supply - reason is: you are in effect taking out a loan from the bank that issued the credit card - only when you pay your credit cared bill at the end of the month is the transaction complete with a debit card the funds to make the purchase are taken directly from your checking account

financial markets

markets where financial securities, such as stocks and bonds are bought and sold

fractional reserve banking system

means that banks keep less than 100 percent of deposits as reserves - when people deposit money in a bank, the bank loans most of the money to someone else - on a typical day, about as much money is deposited as is withdrawn. If a small amount more is withdrawn than deposited, banks can cover the difference from their excess reserves or by borrowing from other banks

Reserve currency as a legal tender

means the federal government requires that it be accepted in payment of debts and requires that cash or checks denominated in dollars be used in payment of taxes

monetary policy has a greater effect on aggregate demand in an open economy than in a closed economy

monetary policy has a greater effect on aggregate demand in an open economy than in a closed economy

store of value

money allows value to be stored easily - if you do not use all of your dollars to buy goods and services today, you can hold the rest to use in the future - any asset: shares of Coca-Cola stock, Treasury bonds, real estate represents a store of value - stocks and bonds offer an important benefit because they pay a higher rate of interest or may increase in value in the future

standard of deferred payment

money can facilitate exchange at a given point in time by providing a medium of exchange and unit of account - money can facilitate exchange over time by providing a store of value and a standard of deferred payment - ex: a computer manufacturer may buy hard drives from another firm in exchange for the promise of making payments in 60 days

why do some firms adjust prices more slowly than others, and why might the wages of workers and the prices of other inputs change more slowly than the prices of final g/s?

most economists believe the explanation is that some firms and workers fail to accurately predict change sin the price level

using GDP equation ( Y = C + I + G + NX ) to calculate saving and investment equation

national saving = domestic investment + net foreign investment or S = I + NFI

open economies

nearly all economies - have extensive interactions in trade or finance with other countries - open economies interact by trading goods and services and by making investments in each other's economies

international trade effect: how a change in the price level affects net exports

net exports = spending by foreign households and firms on goods/services produced in the US minus spending by US households and firms on g/s produced in other countries - if the price level in the US rises relative to price levels in other countries, US exports will become relatively more expensive and foreign imports will become relatively less expensive - a lower price level in the US relative to other countries has the reverse effect, causing exports to rise and increasing the quantity of g/s demanded - it is the third reason the aggregate demand curve is downward sloping

currency depreciation

occurs when the market value of a country's currency decreases relative to the value of another country's currency

currency appreciation

occurs when the market value of a country's currency increases relative to the value of another country's currency.

per-worker production function

often when analyzing economic growth, we look at increases in real GDP per hour worked and increases in capital per hour worked - use measures of GDP per hour and capital per hour rather than per person so we can analyze changes in the underlying ability of an economy to produce more goods with a given amount of labor without having to worry about changes in the fraction of the population working or in the length of the workday perworker production function = the relationship between real GDP per hour worked and capital per hour worked, holding the level of technology constant

the rapid increase in oil prices during 2008

oil prices had been as low as $34 per barrel in 2004, had risen to $140 per barrel by mid-2008 - appeared to be caused by increased demand in rapidly growing economies, particularly in India and China, and by the difficulty in developing new supplies of oil in the short run - rising oil prices can result in a supply shock that causes the short-run aggregate supply curve to shift to the left

balance sheet

on there a firm's assets are listen on the left and its liabilities and stockholders' equity are listed on the right

Foreign direct investment (FDI)

one way for a developing country to break out of the vicious cycle of low saving and investment and low growth - occurs when corporations build or purchase facilities in foreign countries

capital outflow

out of the US when an investor in the US buys a bond issued by a foreign company or government or when a US firm builds a factory in another country

policies that promote saving and investment

policies that increase the incentives to save and invest will increase the equilibrium level of loanable funds and may increase the level of real GDP per capita - investment tax credits: governments also increase incentives for firms to engage in investment in physical capital this way, they allow firms to deduct from their taxes some fraction of the funds they have spent on investment

labor productivity in terms of economic growth models

quantity of goods/services that can be produced by one worker or by one hour of work - economic growth model focuses on the causes of long-run increases in labor productivity a country can be more productive by influencing the quantity of capital per hour worked and the level of technology

hedge funds

raise money from wealthy investors and use sophisticated investment strategies that often involve significant risk

improving health and education

recent initiatives in developing countries to increase vaccinations against infectious diseases, to improve access to treated water and to improve sanitation have begun to reduce rates of illness and death - the rising incomes that result from economic growth can help developing countries deal with the brain drain - brain drain = refers to highly educated and successful individuals leaving developing countries for high-income countries. The migration occurs when successful individuals believe that economic opportunities are very limited in the domestic economy

current account

records current, or short-term flows of funds into and out of country - income received by US residents from investments in other countries; income paid on investments in the US owned by residents of other countries (difference between investment income received and investment income paid is called net income on investments); and the difference between transfers made to residents of other countries and transfers received by US residents from other countries (called net transfers)

capital account

records relatively minor transactions such as migrants' transfers- which consist of goods and financial assets people take with them when they leave or enter a country - and sales and purchases of nonproduced nonfinancial asset

national income accounting

refers to the methods of Bureau of Economic Analysis uses to keep track of total production and total income in the economy GDP: Y = C + I + G + NX

Federal Reserve Act 1913

setting up the Federal Reserve System - began operation in 1914 with the authority to make loans to banks - the loans the Fed makes to banks are called discount loans and the interest rate it charges on the loans is called the discount rate

suppose the government increases spending, which results in a budget deficit

shifting the supply of loanable funds to the left. In the new equilibrium, the interest rate is higher, and the equilibrium quantity of loanable funds is lower

fluctuations in real GDP and the price level are caused by..

shifts in the aggregate demand curve or in teh aggregate supply curve

aggregate demand curve

shows the relationship between the price level and the quantity of real GDP demanded by households, firms and the government

long-run aggregate supply (LRAS) curve

shows the relationship in the long run between the price level and the quantity of real GDP supplied - LRAS curve is a vertical line

what caused the productivity slowdown of 1973 - 1994? (NUMBER 3)

some say it was deterioration in the US educational system that may have contributed to the slowdown in growth - scores on some standardized tests began to decline in the 1970s which may indicate that workers entering the labor force were less well educated and therefore less productive.

start-ups

started by entrepreneurs who found new firms, typically based on new technologies, generally find that investors are unwilling to buy their stocks/bonds because the firm has a lack of records of profitability some obtain funds through venture capital firms: raise funds from institutional investors like pension funds, and from wealthy individuals (ex: Google, relied on venture capitals firms)

Industrial revolution

started in England around the year 1750, the production of cotton cloth in factories using machinery powered by steam engines marked the beginning of the Industrial Revolution - before that, production of goods and relied almost exclusively on human or animal power - mechanical power spreading to goods production greatly increased the quantity of goods each worker could produce

T-account

stripped-down version of a balance sheet that shows how a transaction changes a bank's balance sheet

20th century

technological change had been institutionalized - large corporations began to set up research and development facilities to improve the quality of their products and efficiency with which they produced them - increase in university research

workers in the US

tend to enter the labor force earlier and retire later - experience fewer long spells of unemployment than workers in Europe -studies show that workers who are employed for longer periods tend to have greater skills, greater productivity and higher wages - level of legal protection of investors is relatively high in US financial markets, which encourages both US and foreign investors to buy stocks/bonds issued by US firms

fall 2008 (TARP) Troubled Asset Relief Program

the Fed and Treasury began attempting to stabilize the commercial banking system by providing funds to banks in exchange for stock - taking partial ownership of private commercial banks - the Fed also modified its discount policy by setting up several new "lending facilities" - these lending facilities made it possible for the Fed to grant discount loans to financial firms (like investment banks) that had not previously been eligible

In 2010

the US spent $471 billion more on goods, services and other items in the current account than it received. What happened to that $471 billion? We know that every dollar of that $471 billion was used by foreign individuals or firms to invest in the US or was added to foreign holdings of dollars. We know this because logically there is nowhere else for the dollars to go. - dollars that aren't spent are added to foreign holdings of dollars. Changes in foreign holdings of dollars are known as official reserve transactions

demand and supply in the loanable funds market

the demand for loanable funds is determined by the willingness of firms to borrow money to engage in new investment projects, such as building new factories or carrying out research and development of new products. - In determining whether to borrow funds, firms compare the return they expect to make on an investment with the interest rate they must pay to borrow the necessary funds

small differences in growth rates are important

the difference between 1.3 percent and 2.3 percent may seem trivial, but over long periods, small differences can have a large effect - big differences in living standards

stockholder's equity

the difference between the total value of assets and the total value of liabilities - represents the value of the firm if it had to be closed, all its assets were sold and all its liabilities were paid off

liquidity

the ease with which a financial security can be exchanged for money - providing savers with markets in which they can sell their holdings of financial securities

aggregate supply

the effect of changes in the price level on the quantity of goods/services that firms are willing and able to supply

every day, the equivalent of more than $3 trillion worth of currency is traded in the foreign exchange market

the exchange rates that result from this trading are reported on a number of online sites devoted to economic news and in the business of financial sections of most newspapers

early 1980s

the federal government ran a large budget deficit that resulted in high interest rates, a high exchange value of the dollar and a large current account deficit

financial crisis of 2007-09

the firms in the shadow banking system differed from commercial banks in 2 important ways: the government agencies (not including the Fed) that regulated the commercial banking system did not regulate these firms, and these firms were more highly leveraged (they relied more heavily on borrowed money to finance their operations) than were commercial banks - beginning in 2007 firms in the shadow banking system were quite vulnerable to runs - as housing prices began to fall, a significant number of borrowers began to default on their mortgages, which caused mortgage-backed securities to lose value. Financial firms (both commercial banks and firms in the shadow banking system) that had invested in these securities suffered heavy losses. The more leveraged the firm, the larger the losses. - as lenders refused to renew their short-term loans, many of these firms had to sell their holdings of securities in an attempt to raise cash. But as the prices of these securities continued to fall the loses to these firms increased.

calculating growth rates

the growth rate of real GDP or real GDP per capita during a particular year is equal to the percentage change from the previous year to calculate how long it takes before GDP doubles use the rule of 70: number of years to double = 70/growth rate

market for loanable funds

the interaction of borrowers and lenders determines the market interest rate and the quantity of loanable funds exchanged

person's happiness?

the level of education, life expectancy, crime, spiritual well-being, pollution and many more factors ignored in calculating GDP count toward this

potential GDP =

the level of total production of final goods and services - increases over time as the labor force grows, new factories and office buildings are built, new machinery and equipment are installed, and technological change takes place

fiscal policy in a closed economy

the main effect of higher interest rates is to reduce domestic investment spending and purchases of consumer durables

in a closed economy

the main effect of lower interest rates is on domestic investment spending and purchases of consumer durables

required reserve ratio

the minimum fraction of deposits that banks are required to keep as reserves

quantity theory explanation of inflation

the quantity equation gives us a way of showing the relationship between changes in the money supply and changes in the price level or inflation - growth rate of the money supply + growth rate of velocity = growth rate of the price level (inflation rate) + growth rate of real output or - inflation rate = growth rate of the money supply +growth rate of velocity - growth rate of real output ** if Irving Fisher was correct that velocity is constant, then the growth rate of velocity will be zero so inflation rate = growth rate of the money supply - growth rate of real output

financial system

the system of financial markets and financial intermediaries through which firms acquire funds from households

the total value of saving in the economy must equal the total value of investment

the total value of saving in the economy must equal the total value of investment

recessions of 1990-91, 2001, and 2007-09

the unemployment rate continued to rise even after them - the pattern is typical and due to 2 factors 1. even though employment begins to increase as the recession ends, it may be increasing more slowly than the growth in the labor force resulting from population growth. If employment grows slowly enough relative to the growth in the labor force, it is possible for the unemployment rate to increase 2. some firms continue to operate well below their capacity even after a recession has ended and production has begun to increase. As a result, firms may not hire back all the workers they have laid off and may even continue for a while to lay off more workers

the nominal exchange rate

the value of one country's currency in terms of another country's currency - also known as the real exchange rate, which corrects the nominal exchange rate for changes in prices of goods/services - determines how many units of a foreign currency you can purchase with $1

open economy

there is interaction with other economies in terms of both trading of goods and services and borrowing and lending - all economies today are open economies, although they vary significantly in the extent of their openness

if the federal government runs a budget deficit, the US Treasury must raise an amount equal to the deficit by selling bonds

to attract investors the Treasury may have to raise the interest rates on its bonds. As interest rates on Treasury bonds rise, other interest rates, including those on corporate bonds and bank loans will also rise. - Higher interest rates will discourage some firms from borrowing funds to build new factories or to buy new equipment or computers.

fiscal policy in an open economy

to engage in an expansionary fiscal policy the federal government increases its purchases or cuts taxes. - increases in gov. purchases directly increase aggregate demand - tax cuts increase aggregate demand by increasing household disposable income and business income which results in increased consumption/investment spending

- in 1934 Congress established the Federal Deposit Insurance Corporation (FDIC)

to insure deposits in most banks up to a limit, which is currently $250,000 per deposit - deposit insurance has greatly reduced bank runs because it has reassured all but the largest depositors that their deposits are safe, even if their bank goes out of business

liquidity (2)

volume of trading in the US ensures that investors will be able to quickly sell the stocks and bonds they buy

the nominal interest rate is the stated interest rate on a loan

vs. the real interest rate corrects the nominal interest rate for the effect of inflation and is equal to the nominal interest rate minus the inflation rate

recesion --- adjustment back to potential GDP in the Long Run

we know that a recession will eventually end because there are forces at work that push the economy back to potential GDP in the long run - workers will be willing to accept lower wages because each dollar of wages is able to buy more g/s and firms will be willing to accept lower prices - the unemployment resulting from the recession will make workers more willing to accept lower wages and the decline in demand will make firms more willing to accept lower prices. so SRAS curve will shift to the right ** economists refer to the process of adjustment back to potential GDP just described as an automatic mechanism because it occurs without any actions by the government. An alternative to waiting for it is for the government to use monetary and fiscal policy to shift the AD curve to the right and restore potential GDP more quickly.

primary market

when a financial asset is first sold, the sale takes place in the primary market

foreign portfolio investment (FPI)

when an individual or a firm buys stocks or bonds issued in another country both FPI and FDI can give a low-income country access to funds and technology that otherwise would not be available

most important part of the money supply is the checking account balance component

when banks make loans they increase checking account balances, and the money supply expands. Banks make new loans whenever they gain reserves - if banks lose reserves, they reduce their outstanding loans and deposits, and the moneys supply contracts

the Great Depression of the 1930s

when many banks were hit by bank runs as depositors pulled funds out of checking and savings accounts - although the Fed had been established to act as a lender of last resort, Fed officials declined to make loans to many banks because the officials were worried that banks experiencing runs had made bad loans and other investments - partly due to teh Fed's unwillingness to act as a lender of last resort, more than 5,000 banks failed during the early 1930s

reserve requirements

when the Fed reduces the required reserve ratio, it converts required reserves into excess reserves - the Fed changes reserve requirements much more rarely than it conducts open market operations or changes the discount rate. Because changes in reserve requirements require significant alterations in banks' holdings of loans and securities. It would place a tax on banks' deposit-taking and lending activities making it costly for the economy

monetary policy in an open economy

when the Federal Reserve engages in an expansionary monetary policy, it buys Treasury securities to lower interest rates and stimulate aggregate demand.

budget deficit

when the government spends more than it collects in taxes - In the case of deficit, T is less than G + TR, which means that public saving is negative. Negative saving is also known as dissaving

how movements in the exchange rate affect exports/imports

when the market value of the dollar increases, the foreign currency price of US exports rises and teh dollar price of foreign imports falls - can conclude that a depreciation in the domestic currency will increase exports and decrease imports, thereby increasing net exports. - if real GDP is currently below potential GDP, then, holding all other factors constant, a depreciation in the domestic currency. - an appreciation in the domestic currency should have the opposite effect: exports should fall and imports should rise which will reduce net exports, aggregate demand and real GDP

balance of trade

which is the difference between the value of the goods a country exports and the value of the goods a country imports - largest item in the current account - if a country exports more goods than it imports it has a trade surplus, if a country exports less than it imports it has a trade deficit

lower interest rates

will cause some investors in the US and abroad to switch from investing in US financial assets to investing in foreign financial assets - as a result net exports will increase