ECON 1102
Two growth miracle examples
Japan & South Korea
M won't change GDP in the long run
Money can be doubled in the long run, but it won't change anything else
More investment = more growth
More depreciation = Less growth
Quantity theory of money =
Mv = PY or when Y is fixed, M+v=P+Y
Nominal GDP growth rate equation
New year - old year / old year
What causes cyclical unemployment?
Non keynesians: caused by real shocks that require a reallocation of resources
Reflecting a value approach to investing, the fund will seek the stocks of companies whose current stock prices do not appear to adequately reflect their underlying value as measured by assets, earnings, cash flow, or business franchise
Passive fund
What shifts supply and demand?
People become more thrifty and investors become less optimistic
The factors break the bridge by
Reducing the supply of savings, raising the cost of intermediation, reducing the effectiveness of lending = slow economic growth
At K = 100, Y =√100 =10 Depreciation = 0.03x100 = 3 Investment = 0.3x10 = 3 Investment = Depreciation
Result: Investment = Depreciation K and Y are constant
At K = 225, Y =√225 = 15 Depreciation = 0.03x225 = 6.75 Investment = 0.3x15 = 5 Investment < Depreciation
Result: K and Y decrease
At K = 25, Y =√25 = 5 Depreciation = 0.03x25 = 0.75 Investment = 0.3x5 = 1.5 Investment > Depreciation
Result: K and Y grow
Normal good:
demand increases when income increases
Earning - spending =
debt + assets + cash reserves
Leverage ratio =
debt / equity
Crowding out:
decrease in private spending that occurs when government borrows more
As capital increases what happens to depreciation, output, and investment
depreciation increases constant output increases at a diminishing rate investment is a constant fraction of output
Floating exchange rate
determined primarily by market forces
Cutting edge growth
developing new ideas
Employment at will doctrine
employee may quit and an employer may fire at anytime and any reason
Hyperinflation:
extremely high rates of inflation in the US look pretty tame by comparison
Less painful disinflation is to increase wage flexibility
fed credibility increases wage flexibility
Increasing money supply can decrease real growth and inflation will increase
feds
Active labor market policies
focuses on getting workers back to work
Depreciation rate (𝛿):
fraction of capital that wears out each year depreciation = 𝛿𝐾
Technological knowledge
gain by more research and production, knowledge about how the world works that is used to produce goods
Discouraged workers
given up looking for work but would still like a job
What dominated Argentina and led the fall?
great depression in 1930s 1975-1990 income fell 1980+ led to recession, poor institution
How is economic growth measured?
growth = current year - previous year / previous year x 100
What services are included in GDP?
haircuts, transportation, entertainment, spending on medical care
Real rate < equilibrium rate
harms lenders, benefits borrows
Real variables
have been adjusted for changes in prices (most interested)
Nominal variable
have not been adjusted for changes in prices
Temporary tax investment credit
helps firms invest by giving them a tax break
Depreciation = 0.2 * K Investment = 0.3 * sqrtK Output = sqrt K
higher fraction = higher output
No free lunch
higher returns come at the price of a higher risk
Adaptive expectations
importance of past events in predicting future events
Why does SRAS shift up?
in the long run, unexpected inflation = expected inflation
Demand shifters (6)
income, population, tastes, expectation, price of subs, price of compliments
Monetary policy is less effective at dealing with a real shock
increase in oil leads to lower growth and higher inflation
Inflation:
increase in the average level of prices
Government increases borrowing leads to
increase interest rate, private demand doesn't shift, less private borrowing
Why do poor countries use their capital inefficiently?
inefficient and unnecessary regulations (monopolies, impede markets)
Milton Friedman:
inflation is always and everywhere in the monetary phenomenon
Price confusion:
inflation makes price signals more difficult to interpret
Supply shifters (5)
innovations, taxes and subsidies, expectations, entry or exit of producers, changes in opportunity costs
Capital growth =
investment - depreciation
Investment rate
investment = 𝛿sqrt𝐾
When more capital is accumulated, what happens to MPx
it gets smaller and smaller
Technological knowledge:
knowledge about how the world works that is used to produce goods and services
What does minimum wage do to employment
leads to unemployment
What does GDP not add
leisure, drugs, illegal activities, at home jobs, pollution, crime
Solvency is the same thing as insolvent
liabilities > assets
Poverty
living on less than $1.90 a day
Comparative advantage:
lowest opportunity cost
MPx
marginal product of capital
Capital account
measures changes in foreign ownership of domestic assets, physical or financial
Consumer price index:
measures the average price of goods bought by a typical American consumer
producer price index
measures the average price received by producers (intermediate+final goods)
Shadow banking
money comes from investors
Change in money supply =
money multiplier * deposits
Why do banks securitize?
more liquid cash, balance sheet safer, loan assets can be held by institutions with long term perspective
Best indicator of a recession
negative real GDP growth
Growth rate =
new year - old year / old year x100
Are intermediate goods part of GPD?
no, only final goods. intermediate goods are sold to companies for final goods
Are used goods part of GDP?
no, when they first were final they were
GDP deflator
nominal / real X 100 - 100
GDP deflator equation
nominal GDP divided by real GDP x 100
Real interest rate =
nominal rate - inflation rate
Real rate of return
nominal rate of return minus inflation rate Rreal = i - pie
Market of loanable funds:
occurs when suppliers of loanable funds trade with demanders of loanable funds
Market confidence
one of the feds most powerful tool is its influence over expectations
Output and investment graph
output curve is higher than investment curve
Captial:
output that is saved and invested
Capital:
output that is saved and invested rather than consumed
Working age population
people who are 16+ yr old and not in the military or in college
When economists speak of "long-run economic growth," they mean increasing the:
per capita real GDP of a country
Inflation rate:
percent change in the average level of prices
Structural unemployment
persistent, long term unemployment from long lasting shocks and permanent changes
Factors of production
physical, human, technological
Active investing
picking individual stocks by money mutual funds
Money mutual fund
pool of funds from many investors which a money manager operates
Conditional convergence:
poorer country moves faster than rich country
LRAS
potential growth doesn't depend on inflation rate
Increase in the money supply causes an increase in _____ over the long run
prices
Efficient markets hypothesis
prices of traded goods reflect all publicly available info
Monetizing the debt
printing more money, higher inflation
Human capital
productive knowledge and skills that workers acquire through education, training, and experience
Five institutions of economic growth
property rights, honest government, political stability, a dependable legal system, competitive and open markets
Which GDP grows when the economy grows
real GDP or real GDPC
Financial intermediaries
reduce the costs of moving savings from savers to borrowers and investors
Incentive:
rewards and penalties that motivate behavior
M2
savings deposits, money market mutual funds
Illiquid bank
short term liabilities>assets long run liabilities<assets
Frictional unemployment
short term unemployment caused by difficulties of matching employer to employer
Five effects of price ceiling
shortages, reductions in product quality, wasteful lines and other search costs, a loss in gains from trade, a misallocation of resources
Production possibilities fronter (PPF):
shows all the combos of goods that a country can produce given its labor and supply of inputs
Y = sqrt K K=4, Y=sqrt 4 = 2
shows slowly increasing
SRAS
shows the positive relationship between inflation rate and real growth when prices and wages are sticky
What determines the demand for savings?
smoothing consumption, financing large investments, interest rate
What determines the supply of loanable funds?
smoothing consumptions, impatience, market and physiological factors, interest rates
Marginal product of capital
solow growth shows growth increasing and slowly diminishing
Bond:
sophisticated IOU that documents who owns how much and when payment must be paid
Correlation between wealth and health
strong and positive
Natural unemployment rate
structural + frictional unemployment
Technical analysis
study for patterns in stock and asset prices
Catch up growth
takes advantage of ideas, technologies, or methods of management already in existence
What is the key to long run economic growth
technological knowledge
Three key facts about wealth
1. GDPC today varies from nations 2. Everyone used to be poor 3. There are growth miracles and growth disasters
Three benefits of trade
1. Trade makes people better off when preferences differ 2. Trade increases productivity through specialization and the division of knowledge 3. Trade increases productivity through comparative advantage
Great depression
1929-33
Depreciation is depreciate/capital
2/100
Great recession
2007-09
Real GDP is updated year rates
2009 quantity * 2013 prices
Current account =
-capital account + reserves
Rule of 70 = 70 / %
0 = never 1 = 70 2 = 35 3 = 23.3
Investment is the %*sqrt K
0.3 * 10, other 7 are consumed
Money multiplier =
1 / reserve ratio
Fed regulates other banks, manages the nations payment system, protects financial consumers with disclosure regs
Also regulates the money supply
Two growth disasters
Argentina - 1900 richest country, now poor Nigeria - barely grown since 1950
Past and current chairman of the FED
Ben Bernanke & Janet Yellen
Most share of federal taxes
Income tax, then social security
Present value =
C1/(1+r) + C2/(1+r)^2 + C3/(1+r)^3 + FV/(1+r)^3
Currency
CASH
Difference between the CPI (consumer price index) and the GDP deflator
CPI measures the average prices of goods and services consumed by typical consumers, whereas the GDP deflator measures the average prices of all goods and services in the economy
RR = 10%, deposits = $1,000
Change in deposits / reserve ratio $1000/.10 = 10,000
What happens to college enrollment when there's a recession?
College attendance rates increase
Decreased inflation = decreased real growth
Increased real growth = increased inflation
Increase money supply = buy t-bills
Decrease the money supply = sell t-bills
Rate of return
Face value - price / price x 100
Marginal tax rates are set by government, average tax is after tax is owed
Foreign aid is the smallest
National spending approach
GDP = Cost + investment goods + government purchase + (export - import)
Factor income approach
GDP = wages + rent + interest + profit
GDPC:
GDP divided by population
Increasing spending = higher prices
Higher prices = increase output
Where does inflation come from?
When there is an increase in supply of money
The Solow model equation
Y = F(A,K,eL) Y = total output, K = physical capital, eL = education x labor, A = ideas
Solow model when A, eL are constant
Y = F(K) K = physical capital
Deflation
a decrease in the average level of prices, a negative inflation rate
Insolvency:
a firms liabilities > assets
Dollarization
a foreign country uses US money as currency
Price ceiling
a maximum price allowed by law
GDP deflator:
a price index that can be used to measure inflation
Quota
a restriction on the quantity of goods that can be imported
Tariff
a tax on imports
Unemployed
adults who do not have a job and are looking
Labor force
all workers, employed plus unemployed
Conditional convergence:
amount countries with similar steady state levels of output, poorer countries will grow faster than richer countries
Depreciation:
amount of capital that wears out each period
Liquid asset
an asset that can be used for payments or, quickly and without loss of value, be converted into an asset that can be used for payment
Inflation:
an increase in the general level of prices
Real shock:
any shock that increases/decreases the potential growth rate
Owner equity =
asset - debt
Rate of return equation
asset income - price / price x 100
Monetary base
currency outstanding and total reserves at the Fed
Market equilibrium
at the margin, the gains from holding or spending one currency are equal to holding or spending some other currency
Current account
balance of trade, net income of capital aboard (profits, interest, dividends), net transfer payments
Fractional reserve banking
banks hold only a faction of deposits on reserve
Three main financial intermediaries
banks, bond market, stock market
Real rate > equilibrium rate
benefits lenders, harms borrows
Consumption smoothing
borrow early years, save working years, dissave retiring years
Financial intermediaries:
bridge the gap between savers and borrowers, gather savings to allocate it to the best investments, promote economic growth
Securitization
bundling loans together and selling the bundles as financial assets
RoR is 6% in London and 5% in New York
buy in London, sell in New York
Buy and hold
buy stocks and then hold them for the long run
Open markets operations
buying and selling government bonds
Open market operations and interest rates
buying and selling government bonds changes interest rates buy bond = low interest rate sell bond = high interest rate
At some point depreciation will equal investment
capital stock (steady state) and output will stop growing
Iron logic of diminishing returns
capital stock is low and MPx is high
US cars built in Japan VS Japan cars built in US
cars made in Mexico are NOT included, cars made by Mexico in the US ARE included
Passive funds
choosing a group of stocks that mimic a board market index
Types of price index
consumer price index (CPI), producer price index (PPI), and GDP deflator
Most money used in GDP
consumption
What is the most liquid asset?
currency
Most important assets that serve as means of payment
currency - paper bills/coins total reserves held by Feds checkable deposits-checking/debit account savings deposits, money market mutual funds, small deposits
Dirty (managed) float
currency isn't pegged but kept within a certain range
M1
currency outstanding and checkable deposits
Federal funds rate
the Fed only controls the real IR in short run & the overnight lending rate that banks charge each other
Absolute advantage:
the ability to produce the same good using fewer inputs than another producer
Economies of scale:
the advantages of large scale production that reduce average cost as quantity increases
Money multiplier (MM)
the amount the money supply expands with each dollar increase in reserves
Open market operations
the buying and selling of US government bonds
Arbitrage:
the buying and selling of equally risky assets, ensures that equally risky assets earn equal returns
Fixed (pegged) exchange rate
the central bank has promised to convert its currency at a fixed rate
GDP and GDPC are used to measure?
the changes and differences in standards of living
If the government raises taxes on investment returns, then:
the demand for loanable funds will decrease and the equilibrium interest rate will decrease
Time preference
the desire to have goods
Protectionism
the economic policy of restraining trade through quotas, tariffs, or other regulations that burden foreign producers but not domestic production
Initial public offering
the first time a corporation sells a stock to the public to raise capital
Reserve ratio (RR)
the fraction of deposits held on reserve, determined by how liquid banks wish to be
Who does the FED support?
the governments bank (US treasury), manages government borrowing, banks can borrow from the FED
Discount rate:
the interest rate banks pay when they borrow directly from the Fed
GDP:
the market value of all final goods and services produced within a country in a year
Marginal tax rate:
the percent paid in taxes on an extra dollar of income
Human capital:
the productive knowledge and skills that workers acquire through education, training, and experience
Leverage ratio:
the ratio of debt to equity
The production function is a mathematical function that shows
the relationship between output and the factors of production
Property rights
the right to benefit from ones effort
Systemic risk
the risk that the failure of one financial institution can bring down other institutions as well
Insitutions:
the rules of the game that structure economic incentives
Physical capital
the stock of tools (machines, structures, equipment)
Physical capital:
the stock of tools, structures, and equipment
Moral hazard
the tendency for banks and others to take on too much risk, hoping that the feds will bail them out
Fisher effect
the tendency for nominal interest rates to rise with expected inflation i = E + r equilibrium
The rule of 70
the time it takes to double = 70 / growth rate %
Trade surplus
the value of a country's exports - imports
Trade deficit
the value of a country's imports - exports
Gross national product (GNP)
the value of goods and services produced by US residents no matter where they live
Owner equity
the value of the asset minus the debt
Opportunity cost:
the value of the opportunity lost
Average tax rate
total tax payment divided by total income
Labor force participation =
unemployed + employed / adult population
Unemployment rate =
unemployed / unemployed+employed
Cyclical unemployment
unemployment that is correlated with the business cycle
How to calculate real GDP
use the same years prices
Total reserve
value of accounts banks have at the Fed
Speculative bubbles
when asset prices rise far higher and more rapidly than can be accounted for by the fundamental prospects of the company
Liquidity crisis
when banks are illiquid
Liquidity crisis
when enough depositors want their money back at the same time
Credibility
when people expect the Fed to stick with its policy
Capital surplus
when the inflow of foreign capital is greater than the outflow of capital to other nations
Capital deficit
when the inflow of foreign capital is less than the outflow of capital to other nations
Investment = depreciation
𝛾𝑌=𝛿𝐾
