macro final
Smithian Growth
division of labor is limited by the extent of the market market development allows greater specialization/division of labor greater specialization /division of labor increases labor productivity market development causes economic growth causes market development
First basic idea of SRAS
economic shocks and "sticky" wages and prices result in inflation or deflation impacting output and employment in the short run
natural rate of unemployment
frictional unemployment + structural unemployment
structural unemployment
more people are seeking jobs in labor market than there are jobs available factors that lead to this are minimum wages, labor unions, efficiency wages, gov policies, and mismatches
actual unemployment
natural unemployment + cyclical unemployment
Sticky Wage Theory (SRAS)
nominal wages - slow to adjust to changing economic conditions they don't respond immediately when actual price level is different from what was expected. Businesses have incentives to enter into long term contracts because inflation expectations
Financial markets and intermediaries
financial markets - bond/credit market - equity (stock) market - primary and secondary markets - where financial assets are bought and sold financial intermediaries - the institutions that gather funds from us and convert them into financial assets (examples: commercial banks, insurance companies, investment banks)
how do banks make money?
by loaning the deposits they don't have to keep
shifts in the demand for loanable funds
changes in private investment opportunities changes in government spending
shifts in supply of loanable funds
changes in private savings behavior changes in capital flows an increase of the supply of loanable funds would be caused by higher savings rates or greater net capital inflow
types of money
commodity money - money that takes the form of a commodity like gold, cigarettes, beaver pelts in pre-colonial america Gold standard - gold as money fiat money - money w/o intrinsic value. money because of government decree
direct vs. indirect finance
direct - direct sale of financial security by seller to buyer indirect- role of financial intermediary
MPC
marginal propensity to consume the fraction of extra income that consumers spend (C/Y) size of the multiplier (multiplier theory) depends on the MPC
Inflationary Gap
- Aggregate output is above potential output - AD shifted to the right! - so, upward pressure on wages/prices because demand is pulling inflation. in the long run wages will go up and eventually SRAS will shift to the left because higher wages means less money to produce.
Demand Shock
- An event that shifts the AD curve - negative demand shock would reduce demand
What shifts the SRAS curve?
- Changes in commodity prices: an increase in the price of a commodity shifts the curve to the left and a decrease in the price shifts it to the right - Changes in nominal wages: increase in nominal wages shifts it to the left and decrease to the right - Changes in productivity: more productivity shifts to the right and less shifts to the left
Determinants and Shifters of Aggregate Demand
- Exports and Imports and determinants Shift: - C, I, G, or NX - Components of AD will change because of: - changes in expectations - changes in wealth - size of the existing stock of physical capital (if you already have too much of something, there is less demand for it) - monetary/fiscal policy - if a change in price level is not caused by a component of real GDP then it will result in a movement along the AD curve not a movement of the curve
Aggregate Demand and Fiscal Policy
- Fiscal Policy - the use of government spending or tax policy to stabilize the economy. Governments often respond to recessions by increasing spending, cutting taxes, or both. The response to inflation is reducing spending or increasing taxes. - The effect of G (gov purchases on final goods and services) on aggregate demand is direct b/c G is a component of aggregate demand. Increase in G is an increase in AD. - Changes in tax rates or government transfers effects AD indirectly. It affects consumer income and then that affects demand.
AD and Monetary Policy
- Monetary Policy is controlled by the Federal Reserve and is the use of changes in the quantity of money or the interest rate to stabilize the economy - Increasing the quantity of money in circulation shifts the aggregate demand curve to the right - Decreasing the quantity of money in circulation raises interest rates, reduces investment spending and consumer spending, which shifts the AD curve to the left
LRAS vs. SRAS curves
- SRAS is an upward slope because as price levels go up, more firms will produce more but wages of workers and price of resources stay the same. Sticky nominal wages. - LRAS is vertical because when prices go up, the wages of the workers will also increase. The actual amount produced will not increase because wages also are going up. It is vertical at the full employment level of output. Where the line touches the horizontal axis, that is the economy's potential output - the level of real GDP the economy would produce if all prices including nominal wages were fully flexible.
What shifts the LRAS curve?
- Same things that cause a shift in the production possibility frontier (where inflation/deflation don't affect the model either) - think about it (PRODUCTION POSSIBILITY vs POTENTIAL OUTPUT) - changes in : labor, natural resources, instructional structure, capital, human capital, technology, productivity - these are the factors that underlie long term economic growth
Recessionary Gap
- aggregate output is below potential output - AD shifted to the left! - there is downward pressure on wages so eventually they will fall. Demand is pushing deflation. So, in the long run because wages fell, supply will go up and SRAS will shift to the right.
Supply Shock
- an event that shifts the SRAS curve - negative supply shock would raise production costs and reduce supply - different from demand shock in that it causes aggregate price level and aggregate output to move in opposite directions
Money definition
- money is an asset that people are generally willing to accept in exchange for goods and services or for payment of debts - money is one the most important inventions of mankind - Money is tied to Smithian growth - no money, less markets, less specialization, less productivity, reduced standard of living
Responding to demand shocks
- negative demand shocks can be fixed with fiscal or monetary policy
Short Run AS determinants
- same as long run except it also includes the money side of the economy where there are wage and price rigidities, economic shocks and price level misconceptions. - The impact of inflation or deflation on a nation's output of goods and services in the short run - Changes in the overall price level can affect a nation's GDP in the short run - potential GDP plus financial or production cost factors
Stagflation
- the combination of inflation and falling aggregate output - basically negative supply shock - When the SRAS shifts to the left, aggregate price level goes up and output goes down - Leads to rising unemployment and rising prices
Federal Funds Rate
- the interest rate paid on money banks borrow from each other (commercial bank to commercial bank) on a very short term (overnight) basis. Fed indirectly controls the federal funds rate so it is sometimes called the targeted federal funds rate. by decreasing or increasing the targeted fed. funds rate, the fed encourages or discourages banks to borrow from each other. - the foundation rate
Discount Rate Policy
- the interest rate paid on money banks borrow from the Fed on a very short term (overnight) basis. By decreasing or increasing the discount rate, the Fed encourages or discourages bank to borrow more money from the Fed. the Fed directly controls the discount rate.
Responding to supply shocks
- unlike demand shocks, there is no easy answer like a policy to fix supply shocks - if you try to shift the aggregate demand curve to the right in response to a negative supply shock then output will decrease and inflation will go up - if you shift the aggregate demand curve to the left it curbs inflation but increases unemployment
Investors are happy to keep lending to the US in good times and bad, regardless of how much it borrows... why?
1. US Economic Growth is strong (stronger than Europe's and other regions 2. no risk of default 3. interest rate higher than alternative interest rates (like Germany or somewhere else)
money's 4 primary functions
1. medium of exchange (accepted for payment for goods and services) 2. unit of account (allows ways of measuring value) 3. store of value (money allows people to defer consumption until later by storing value 4. standard of deferred payment (money facilitates exchanges across time when we anticipate that its value in the future will be predictable)
simple money or deposit multiplier
1/rr
Change in M1 =
1/rr * change in reserves
Schumpeterian Growth
Capitalism is dynamic The process of creative destruction: central element of technological change the entrepreneur: central motive force in driving innovation and technological change new products, new technology, new organization, new sources of supply
Growth vs. Development
Economic growth is a necessary but not sufficient condition for development Development: expansion of individual capabilities. accessible healthcare, basic education, adequate nourishment and civil and social stability. the ability to fulfill a minimally acceptable life. Economic development is tied to distributional issues and human development
What caused the Great Depression? the Housing boom of early 2000's?
GD: Decrease in aggregate demand caused a large drop in real GDP Decreased C and I Housing Boom: decreased in aggregate demand because of reduced I and C
The Multiplier Theory
Government purchases can move aggregate demand curve to the right and the consumer spending goes up because of it and the aggregate demand curve moves to the right again MPC - consumer spends a little extra, another round of income, brings another round of expenditure, ripple effect 1/1-MPC
Human capital vs. physical capital
Human capital is the improvement in labor created by the education and knowledge embodied in the workforce Physical capital consists of human-made resources such as buildings and machines
BOND PRICES FALL
INTEREST RATES RISE and vice versa
M1 vs M2
M1 - demand deposits, traveler's checks, other checkable deposits, currency M2 - everything in M1, savings deposits, small time deposits, money market mutual funds, a few minor categories when we talk about money supply we are typically talking about M1 because we are interested in money's role as the medium of exchange
What determines labor productivity?
Market and Production Organization (specialization within a firm) Physical Capital per worker human capital per worker technological knowledge/innovation - labor productivity = Y/L what drives y/l over time? increases in K, T and H (T most important)
Quantity Theory of Money
Money = M Velocity of Money = V (how many times its spent in a year Real GDP = Y Price of G+S = P P*Y = Nominal GDP (actions of sellers) M*V = Nominal GDP (actions of buyers) MV = PY
financial assets
loans, bonds, loan backed securities, stocks financial assets are financial security instruments commercial banks have 15.7% of f. assets life insurance companies 7.4% others have 73.6%
Rule of 70 - Why do growth rates matter?
Number of years to double = 70/growth rate
Modern Growth Theories
Original Growth Theories: technology critical but no real explanation of how technological change occurs New Growth Theories: same framework but seek a better understanding of what determines technological change
Why the AD curve looks the way it does
Real Wealth effect Interest Rate Effect International Trade Effect
Adam Smith
Relative deprivation of income can result in absolute deprivation of basic capabilities necessary goods defined differently across societies A country's wealth is determined by labor productivity and productive labor/unproductive labor
Long Run AS determinants
The level of real GDP is determined by the number of workers, the level of technology, and the capital stock and institutional framework In the long run, the overall price level does not effect the long run determinants of GDP Long run is time period when prices and wages are completely flexible
Investment Banks
They advise corporations regarding their capital structure (should they borrow vs. sell more stock) and other things like mergers and acquisitions and provide what is referred to as underwriting services
Why do incentives matter?
because they determine whether or not a society moves toward positive vs. zero/negative sum outcomes positive sum outcomes means all parties are better off and the economic pie gets bigger zero/negative sum outcomes means one party is better off, the other is worse off and the economic pie contracts or stays the same
Aggregate Production Function
Y = L + K + H + N + E + T labor, capital, human capital, natural resources, entrepreneurial abilities, technology
phillips curve
a curve that shows the short-run trade-off between inflation and unemployment.
The Production Function
a short hand graphical framework that connects labor productivity with factors that drive sustained labor productivity growth what causes the per person production function (labor productivity) to increase over time? INNOVATIONS AND TECHNOLOGICAL CHANGE
Financial System
a stable and well functioning financial system is critical to economic growth 1. encourages greater savings 2. encourages greater investment 3. efficiently channels savings into investment The financial system takes the surplus of an economy and channels it to that part of the economy that has a deficit - reduces overall risk/diversify assets - lower overall costs of borrowing/lending - provide liquidity
Commercial Banks
accept deposits, make car loans (investment banks don't do that stuff)
positive output gap/ inflationary gap
actual GDP - Potential GDP / potential GDP * 100
Negative Output Gap/ recessionary gap
actual gdp - potential gdp / potential gdp * 100
cyclical unemployment
actual rate of unemployment - natural rate
When the aggregate price level falls, the purchasing power of assets rises, which leads to:
an increase in the quantity of aggregate output demanded
US Government debt
funds its current deficits with borrowing. borrow by selling treasury bonds, notes and bills. current total debt is 22 trillion our total gov debt swamps private debt higher interest rates will eventually lead the US government to spend more on interest than it does on medicaid, national defense, funding for national parks, scientific research, health care, education, court system, all WELFARE PROGRAMS!!!
What determines long term economic growth?
income per capita (Y/pop) is driven by labor productivity (Y/L) a nation's standard of living is determined by its ability to produce goods and services long run variations in countries' standards of living is driven almost entirely by labor productivity
primary/secondary capital market
primary - initial sale of stocks/bonds and the issuers get the money secondary - reselling of existing stock/bonds and issuers don't get the money
Fisher Effect
real interest rate = nominal rate - inflation rate basically market interest rate = stated interest rate - inflation rate
Natural Rate of Output
reflects the production of goods and services (real GDP) that an economy achieves in the long run also called potential output or full-employment output *the rate of unemployment at the natural rate of output is the natural rate of unemployment
External Economies
specialized producers within industrial districts create external economies the concentration of production in a particular location generates external benefits for firms in that location through knowledge spillovers, labor pooling, and close proximity of specialized suppliers the reason why everyone wanted the amazon location to be in their city
Second basic idea of SRAS
the SRAS fundamentally represents the overall cost of production. So when the overall costs change (think economic shock or higher wage structure) then the SRAS changes. Everything that causes the LRAS to change causes SRAS to change but its not the reverse
Required reserve ratio
the amount of money that banks are required to keep in reserves. that is why sometimes banks have to borrow money overnight from the Fed if people want to withdraw a large sum of cash. currently it is 10% so for every 1000 in deposits a bank gets it must keep 100 in reserve an increase in RR would result in fewer loans being made the Fed rarely alters the RR
big idea 1 of open market operations
the buying of US gov. bonds by the Fed increases the banking reserves and our money supply the selling of US gov. bonds by the Fed decreases the banking reserves and our money supply
The Federal Reserve
the central bank of the US. the Fed;s issuance of currency is fiat money US currency is money because our government says that it is
Crowding out effect
the loss of funds for private investment due to government borrowing In the short run it depends on level of recessionary gap, how sensitive private investment is to the change in interest rates and net capital inflow
What causes economic growth?
the role of cities (clustered economies), role of culture (ex: religion), geography, institutions (dependable legal system, market organization, political stability, education, monetary framework), climate (immunity to diseases in England), growth theories (what determines technological change?) Capital formation, human capital formation and technological progress are all critical for economic growth and all require investment Technological change causes an increase in labor productivity which then causes and increase of the PPC
Stabilization Policy
the use of government policy to reduce the severity of recessions and rein in excessively strong expansions
frictional unemployment
unemployment due to the time workers spend in job search
Agglomeration economies
when a bunch of firms locate near each other and this generates a cavalcade of new ideas and human capital accumulation economic clustering not all positive effects but the advantages are that cities have been engines of innovation
Convergence
when the per capita income of developing countries converge toward that of developing countries absolute convergence: per capita income of developing countries will equal that of developed countries conditional convergence: per capita income of developing countries will equal that of developed if they have the same rate of savings, population growth rate, and production function
FOMC - federal open market committee
where monetary policy is formulated discuss and evaluate the health of the economy consider and determine monetary policy changes they act as a lender of last resort, the commercial banker's bank, regulates banks, and responsible for managing the nation's money supply in short term interest rates in implementing monetary policy
