ECN 13

Given the euros/dollar exchange rate, identify the dollars/euro exchange rate.

$2/e1 is e1/$2 or e.5/$1

Ceteris paribus, show how a specified shift of either supply or demand in the long term capital market changes the level of investment. Then show in our Macro Picture how this change in investment affects the aggregate economy.

A shift in supply or demand shifts the level of investment. The ad line will shift because investment is a shift factor for AD which shifts the macroeconomy.

Describe how the U.S. budget is determined.

Congressional, presidential system, parliamentary system, or dictatorship determines budget position. The US uses a presidential proposal that goes through congress converged into a joint committee of the two houses and is put into a single budget bill and is signed by the president.

Explain why international capital flows are often the most volatile source of entry or exit.

Constantly moving investments based on stability and attractiveness of a country. It is often changing, especially because countries economies are becoming more and more woven together.

Write out and name the equation that represents the sources of consumption in the aggregate economy.

Consumption function C=b(PY) +A

Identify and explain each letter in the consumption function.

Consumption. Marginal propensity to consume. Price Level. GDP. Autonomous consumption.

Ceteris paribus, using all appropriate graphs (appropriately labeled), show and explain how a shift out in the demand for financial capital in the United States affects U.S. interest rates, and (assuming some of the increased quantity supplied comes from overseas) how this in turn affects the dollar exchange rate, the trade balance, the aggregate demand and the macroeconomy. Ceteris paribus, do the same for a case of falling demand for financial capital.

Demand for financial capital increases. Interest rates increase when demand increases. The dollar gets stronger. Imports become greater than exports so the trade balance is negative. Aggregate demand decreases because there is an increase in imports and decrease in exports

Explain why most international trade requires exchange of currencies.

Different countries use different currencies.

On an appropriately labeled capital market picture, show how entry into a country's capital market will shift the capital supply line.

Entry into a country's capital markets shifts the supply line right because there are increase quantity of funds which means an increase in investment and decrease in interest rates. Flows into a country occur when it is relatively more attractive than another country.

Describe the relationship between domestic wealth accumulation and entry or exit into a nation's capital market. Describe examples.

Entry makes a country wealthier because because there are increase quantity of funds which means an increase in investment and decrease in interest rates. Increase investment shifts AD to the right, which increase real GDP and decreases unemployment.

On appropriately labeled graphs, ceteris paribus, show how an international capital flow into a country affects that country's capital market and in turn its macroeconomy.

Entry makes a country wealthier because because there are increase quantity of funds which means an increase in investment and decrease in interest rates. Increase investment shifts AD to the right, which increase real GDP and decreases unemployment.

Explain the concept of "smoothing out" consumption over time.

Even with ups and downs in financial situations one usually is consistent and smooth with the way they consume in the long term

Describe the relationship that must exist between the expected rate of return and the interest rate for an investment to make sense. Explain.

Expected rate of return > interest rate so the cost outweighs the benefit

Ceteris paribus, describe how a specified change in the short rate capital supply and/or inflationary expectations will shift the long term capital supply line.

Falling short rate line pulls the long line down. If inflationary expectations rise, long rate supply line shifts up. If both go opposite ways it depends on which dominates.

Define: financial capital. Distinguish financial capital from real, production capital.

Financial capital: liquidity funds that pass through the capital market real, production capital: produced means of production, fixed in form

Describe the role of financial intermediaries in the capital market. Identify some financial institutions that serve as financial intermediaries.

Financial intermediaries: financial institutions that coordinate the exchange of liquidity between lenders and borrowers. Banks and mutual funds.

Explain why international trade exists.

Gains from trade when individuals or nations specialize then exchange surpluses

Define: international capital flows.

International capital flows: flow of funds from one country's capital market to another country's capital market.

Explain why the market in which financial capital is exchanged for real investments is the long term capital market.

Investments take a significant time between the loan made and investment paying off, so borrowers take a long time to pay it off. These are long term loans.

Explain why financial capital is often referred to as liquidity.

It is not fixed in form and takes any shape we pour it into. Takes the shape of the investment

Ceteris paribus, tell the same stories about the U.S. economy as described in Objective 14, but let the shift in demand for financial capital be in the Japanese capital market.

Japanese capital market investment increases. US supplies financial capital to Japanese LTCM. US dollar becomes weaker so we export more to japan than import, making the trade balance positive. AD increases because exports increase and imports decrease.

Identify the three factors that determine the level of long term capital supply.

Level of short term supply line, the waiting premium, and the inflationary expectations premium.

Identify the market in which the level of investment is determined.

Long term capital market

Explain the "b(P*Y)" in the consumption equation.

Marginal propensity to consume (b): the share of every dollar that is used to consume. the share of the current aggregate income that people use for consumption. Level of consumption = b(Y*P). (b-1)(Y*P) is what is being saved.

Explain why people go to the long term capital market for investment funds.

Need loans in order to cover the cost of investments because it is rare that they have enough funds.

On an appropriately labeled graph, ceteris paribus, show how increasingly negative expectations shift the capital market demand line. Then explain and show on an appropriately labeled Macro Picture how this change in expectations in the capital market affects the macroeconomy.

Negative expectations makes a country worse off because there are decrease demand of funds which means a decrease in investment and consumption and decrease in interest rates. decrease investment shifts AD to the left, which decreases real GDP and increases unemployment.

Identify the conditions that determine the government's budget position.

Net aggregate effect of how much it spends and how much it taxes.

Describe a global financial panic. Explain the underlying conditions and kinds of events that can lead to such a panic. Describe an example.

People quicklywithdrawing investments in a country due to panic or instability. Asian conatgion.

Define: permanent income. Describe the relationship between permanent income and consumption.

Permanent income: long term expected income status. Consumption is a function of permanent income.

Describe personal financial planning.

Personal financial planning: arranging consumption, saving and financial investment patterns so that your long term ability to consume will be at least constant or start to improve

On an appropriately labeled graph, ceteris paribus, show how increasingly positive expectations shift the capital market demand line. Then explain and show on an appropriately labeled Macro Picture how this change in expectations in the capital market affects the macroeconomy.

Positive expectations makes a country wealthier because there are increase demand of funds which means an increase in investment and consumption and increase in interest rates. Increase investment shifts AD to the right, which increase real GDP and decreases unemployment.

Critique the following assertion: Strong currencies are good and weak currencies are bad.

This depends on the situation and job. A weak currency may help stimulate an economy because more items will be exported. A stronger economy means more imports than exports and you can buy more with your money. It depends what an individual, business or a nation needs.

On an appropriately labeled capital market picture, show how exit from a country's capital market will shift the capital supply line.

exit out of a country's capital markets shifts the supply line left because there are decreased quantity of funds which means a decrease in investment and increase in interest rates. Flows out of a country occur when it is relatively less attractive than another country.

Define: expected rate of return. Give an example.

expected rate of return: the rate at which a demander believes they will gain from a given number of dollars invested. If the expected rate of return is 10% and one invests $100 they expect to gain $10 and make $110.

Explain what it means for a currency's value to be allowed to "float" in the foreign exchange market.

float: exchange rate is allowed to adjust freely allowing the foreign exchange market to reach equilibrium at which quantity supplied equals quantity demanded.

Explain the concept of foreign direct investment. Give an example.

foreign direct investment: holders of international capital send their funds and make actual investments in themselves.

Identify the market in which nations' currencies are exchanged.

foreign exchange market

Describe the conditions that, ceteris paribus, lead to flows of international capital out of a country. Give examples.

instability, unattractiveness, low interest rates

Explain why international capital flows are playing a bigger and bigger role in the economies of individual nations.

national economies are becoming more and more woven together into the global system through global communication

Describe how perceptions of risk of default affect interest rates.

risk of default: wont get the funds supplied back. Interest rates are higher for riskier demanders, or lower for safe demanders.

Describe the conditions that, ceteris paribus, lead to flows of international capital into a country. Give examples.

stability, attractiveness, high interest rates

Identify the basis on which the average individual determines her level of consumption.

the standard of living she thinks is consistent with her long term financial situation.

Explain and show graphically how achieving peace in previously a war-torn nation can, ceteris paribus, increase investment and improve macroeconomic conditions.

Achieving peace leads to Positive expectations, stability and increased investment in the country makes a country wealthier because there are increase demand of funds which means an increase in investment and consumption and decrease in interest rates. Increase investment shifts AD to the right, which increase real GDP and decreases unemployment

Identify the source of aggregate income in the economy and how we measure it in our model.

Amount of production in the economy . the funds paid for that production become peoples income. It is measured by the price level times the GDP.

Explain the effect of expectations on capital market demand.

As investor's expectations become more positive, more investments look good at any given interest rate.

Explain how unfolding events can dramatically shape budget decisions. Give an example.

Attacks on the country such as pearl harbor lead to dramatic government spending to increase the war effort.

Define: autonomous consumption. Give examples.

Autonomous consumption: consumption out of accumulated wealth (spending based on assets like house value, stocks by retirees or laid off workers).

Explain why the long term capital demand line slopes down.

Borrowing for an investment only makes sense if the expected rate of return is greater than the interest rate to make the investment. The higher the interest rate, the less likely the expected benefits will outweigh the cost, so less will demand.

Explain how consumer confidence affects the aggregate level of consumption.

If a consumer sees their prospects as brightening and they sense that the future is secure, they are more comfortable spending outside of their accumulated wealth. Marginal propensity to consume "b" increases because they feel ore confident they can afford a bigger lifestyle. Leads to an increased level in consumption "C." as C increases, AD shifts right increasing Real GDP. As people spend less, it results in less income, because real GDP decreases.

Describe and explain the market forces that, under normal circumstances, would slow down the outward flow of financial capital and ultimately stop it before it became a hemorrhage?

Increase in exports, because falling prices means its weaker compared to other currencies, which allows others to buy more with less, stimulating an economy.

Identify and explain how parties that are not officially part of the budget position determination try to influence the budget process.

Interest groups with financial means influence decision making process through campaigns and lobbyists.

Explain the relationship between international capital flows and entry or exit into a nation's capital market. Describe examples.

International capital flows are the funds that enter or exit a country's capital market. There is a civil war in Liberia and investors exit Liberia because it is unstable and invest in the US because it is stable.

Draw and label a long term capital market picture. Explain each axis.

Quantity of financial capital: increasing amount of funds interest rates: price of liquidity/ financial capital

Describe the relationship between short term interest rates and long term interest rates.

Short term loans have a smaller interest rate than long term loans because people discount the future so the longer the loan, the more they need to be compensated for the waiting with premiums.

Suppose the demand for dollars by folks holding euros expands. Show what this would look like on an appropriately labeled graph in which dollars are the commodity. Show what this would look like on an appropriately labeled graph in which euros are the commodity.

Supply line of the euro market will shift right and the demand line of the dollar market will shift right.

On appropriately labeled graphs, ceteris paribus, show how an international capital flow out of a country affects that country's capital market and in turn its macroeconomy.

exit makes a country worse off because there are decrease quantity of funds which means a decrease in investment and increase in interest rates. decrease investment shifts AD to the left, which decreases real GDP and increases unemployment.

Explain the role of expectations in the long term capital demand.

The expected rate of return will determine whether the cost of demanding a loan outweighs the benefits of the return. The expectation dictates whether the demand

Explain and show graphically how the depression of the Great Depression contributed to the depths the U.S. economy sank into.

The great depression meant there were Negative expectations. People believed there were less opportunities ahead so the country was worse off because there are decrease demand of funds which means a decrease in investment and consumption and increase in interest rates. decrease investment shifts AD to the left, which decreases real GDP and increases unemployment.

Explain why the long term capital supply line slopes up.

The higher the interest rate, the more suppliers are willing to loan out, which leads to an upward sloping supply line. The higher the interest rate, the more attractive supplying is than the opportunity cost.

Describe the relationship between the two exchange rates: euros/dollar and dollars/euro.

The rate from one perspective is the reciprocal of the rate from another

Identify the premiums that are added on to the short rate line to establish long rates. Explain each premium.

Waiting premium: because of our discount rate, the longer the loan, the more the lender wants to be compensated for waiting. inflationary expectations premium: longer loans are more vulnerable to inflation, which reduces the real value of the loan.

Describe the wealth effect and its role in determining the aggregate level of consumption.

Wealth effect: as the value of assets increase people perceive themselves to be wealthier (stocks. They are just paper) based on the assumption that these values will still be high when they decide to sell them. Marginal propensity to consume "b" increases because they feel ore confident they can afford a bigger lifestyle. Leads to an increased level in consumption "C." as C increases, AD shifts right increasing Real GDP. As people spend less, it results in less income, because real GDP decreases.

Describe what it means for a currency to get weaker or to get stronger. Give an example.

a currency gets stronger because it will buy more of a different currency. If it is weaker, it can buy less. As one gets stronger, by definition the other gets weaker.