Macro Exam 2

Consumer Wealth (2 types)

1. Financial Wealth - stocks, bonds, savings 2. Consumer Durable Goods - cars, refrigerators, washing machine, furniture, etc.

Three Functions of Money

1. Medium of exchange: Money can be used for buying and selling goods and services. If there were no money, goods would have to be exchanged through the process of barter (goods would be traded for other goods in transactions arranged on the basis of mutual need). For example: If I raise chickens and want to buy cows, I would have to find a person who is willing to sell his cows for my chickens. Such arrangements are often difficult. But Money eliminates the need of the double coincidence of wants. 2. Unit of account: Money is the common standard for measuring relative worth of goods and service. 3. Store of value: Money is the most liquid asset (Liquidity measures how easily assets can be spent to buy goods and services). Money's value can be retained over time. It is a convenient way to store wealth.

Inflation

A general increase in prices and fall in the purchasing value of money.

Excess Reserves

Capital reserves held by a bank or financial institution in excess of what is required by regulators, creditors or internal controls. For commercial banks, excess reserves are measured against standard reserve requirement amounts set by central banking authorities. These required reserve ratios set the minimum liquid deposits (such as cash) that must be in reserve at a bank; more is considered excess. Financial firms that carry excess reserves have an extra measure of safety in the event of sudden loan losses or cash withdrawals by customers. This may increase the attractiveness of the company that holds excess reserves to investors, especially in times of economic uncertainty. Boosting the level of excess reserves can also improve an entity's credit rating, as measured by ratings agencies like Standard & Poor's. Reserves need to be in liquid forms of capital such as cash in a vault, which does not create income. Banks will therefore try to minimize their excess reserves by lending the maximun allowable amount to borrowers.

noneconomic costs of unemployment

For the individual, noneconomic costs include adverse effects on mental and physical health, adverse effects on the family, higher rates of alcoholism and drug abuse, and higher crime and suicide rates.

Frictional Unemployment

Frictional Unemployment is always present in the economy, resulting from temporary transitions made by workers and employers or from workers and employers having inconsistent or incomplete information. This type of unemployment is closely related to structural unemployment due to its dependence on the dynamics of the economy. It is caused because unemployed workers may not always take the first job offer they receive because of the wages and necessary skills. This type of unemployment is also caused by failing firms, poor job performance, or obsolete skills. This may also be caused by workers who will quit their jobs in order to move to different parts of the country. Frictional unemployment can be seen as a transaction cost of trying to find a new job; it is the result of imperfect information on available jobs. For instance, a case of frictional unemployment would be a college student quitting their fast-food restaurant job to get ready to find a job in their field after graduation. Unlike structural unemployment this process would not be long due to skills the college graduate has to offer a potential firm.

Quantity Theory of Money

In monetary economics, the quantity theory of money states that money supply has a direct, proportional relationship with the price level. For example, if the currency in circulation increased, there would be a proportional increase in the price of goods. Ms * V = P * Q where Ms is the money supply, V is the velocity, P is the price level, and Q is the quantity of output. or Money Supply × Velocity of Money = Price Level × Real GDP.

economic costs of unemployment

Loss of earnings to the unemployed Those who are unemployed will find it more difficult to get work in the future (this is known as the hysteresis effect) Increased govt borrowing (PSNCR). Tax revenue will fall because there is less people paying income tax and VAT. Also the govt will have to spend more on unemployment benefits. Lower GDP for the economy, the economy will be below full capacity this is inefficient and will lead to lower output and incomes.

3 Major Economic Effects of Inflation

Price effects. As the average level of prices increase, some prices increase faster than others, so some people are more affected than others. The increase in gasoline prices in the summer of 2000 hurt truckers a lot, but barely affected people who live close to work and drive economy cars. College tuition has risen almost twice as fast as average prices over the past 20 years, which hurts you a lot, but may have little impact on a married couple with no children. Income effects. Prices for goods and services mean incomes for someone else. So as some prices increase faster than others, some incomes increase faster than others. Oil companies posted record profits in the summer of 2000. Wealth effects. Inflation redistributes income between borrowers and lenders. Suppose you borrow $100,000 for a 30-year mortgage at 7% interest, giving you a monthly housepayment of about $665. During the next 30 years, as prices rise, that $665 buys less and less. So as a borrower, the real value of your housepayment declines. Thus a borrower may gain from high inflation. The lender however, receives $665 per month, so the lender loses. If inflation is high enough the $239,400 the lender receives in loan and interest repayment over the next 30 years ($665 x 12 months x 30 years) will be worth LESS in real terms than the $100,000 the borrower receives today. Inflation hurts lenders but benefits borrowers, especially if it is unexpected. So the Wall Street banker is much more worried about inflation than Joe Average with a mortgage and a car payment.

Structural Unemployment

Structural Unemployment, one of the three types of unemployment, is associated with the mismatch of jobs and workers due to the lack of skills or simply the wrong area desired for work. Structural unemployment depends on the social needs of the economy and dynamic changes in the economy. For instance,advances in technology and changes in market conditions often turn many skills obsolete; this typically increases the unemployment rate. For example, laborers who worked on cotton fields found their jobs obsolete with Eli Whitney's patenting of the cotton gin. Similarly, with the rise of computers, many jobs in manual book keeping have been replaced by highly efficient software. Workers who find themselves in this situation find that they need to acquire new skills in order to obtain a new job.

GDP gap

The GDP gap or the output gap is the difference between actual GDP or actual output and potential GDP. The calculation for the output gap is Y-Y1 where Y is actual output and Y1 is potential output.

Inventory Adjustment Mechanism

The basic equillibriating force in the Keynesian Cross. When planned expenditure is not the same as actual expenditure, then inventories will adjust and bring planned and actual expenditure into equality.

Default Risk

The event in which companies or individuals will be unable to make the required payments on their debt obligations. Lenders and investors are exposed to default risk in virtually all forms of credit extensions. To mitigate the impact of default risk, lenders often charge rates of return that correspond the debtor's level of default risk. The higher the risk, the higher the required return, and vice versa. Measured by credit scores for consumers, and credit ratings for governments and businesses.

Federal Discount Rate

The interest rate set by the Federal Reserve that is offered to eligible commercial banks or other depository institutions in an attempt to reduce liquidity problems and the pressures of reserve requirements. The discount rate allows the federal reserve to control the supply of money and is used to assure stability in the financial markets.

Cyclical Unemployment

Unemployment that is attributed to economic contraction is called cyclical unemployment. The economy has the capacity to create jobs which increases economic growth. Therefore, an expanding economy typically has lower levels of unemployment. On the other hand, according to cyclical unemployment an economy that is in a recession faces higher levels of unemployment. When this happens there are more unemployed workers than job openings due to the breakdown of the economy. This type of unemployment is heavily concentrated on the activity in the economy.

Effects of Unanticipated Inflation on Creditors

Unexpected inflation always redistributes wealth from people who have contracted to receive fixed nominal amounts (creditors) in the future to the people who have contracted to pay those fixed nominal amounts (debtors).

Velocity of Money

refers to how fast money passes from one holder to the next. It can refer to the income velocity of money, which is the frequency at which the average unit of currency is used to purchase newly domestically-produced goods and services within a given time period.[3] In other words, it is the number of times one dollar is spent to buy goods and services per unit of time.[3] Alternatively and less frequently, it can refer to the transactions velocity of money, which is the frequency with which the average unit of currency is used in any kind of transaction in which it changes possession—not only the purchase of newly produced goods, but also the purchase of financial assets and other items. Nominal GDP / Money Supply or (Price Level x Real GDP)/Money Supply