ECON 1102

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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


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