Econ103 University of Delaware Final

Federal Reserve

"central bank" made to stabilize monetary policy -Composed of 12 Federal Reserve Banks, which collectively serve as US central bank

Unemployment Rate

(# Employed/Labor Force) *100

Real Income

(Nominal Income/CPI)*100

Consumer Price Index (CPI) Equation

(Price of Market Basket Presently/Price of Basket in Base Yr)* 100

Main Points about Consumption

1. Consumption can be greater than disposable income (person must be borrowing) or consumption can be less than disposable income (person is saving) 2. Consumption increases as disposable income increases 3. Consumption falls as a percentage of income as income rises

Non-interest Rate Determinants of Investment

1. Cost of Capital Goods: inverse relationship 2. Business Taxes: inverse relationship 3. Technology: positive relationship 4. Stock of available capital goods: inverse relationship 5. Planned Inventory Changes: positive relationship 6. Expectations: positive relationship

Changes to Equilibrium

1. Decrease to AD leads to recession & unemployment 2. Increase in AD leads to demand pull inflation 3. Decrease in AS leads to cost push inflation 4. Increase in AS leads to growth

Types of Unemployment

1. Frictional: skill set is no longer needed 2. Structural: unemployed workers unlikely to find new jobs with their current skill set (ex- shoemakers after industrial rev) 3. Cyclical: business cycles

Functions of Fed

1. Issues Currency: issues paper currency used in US monetary system 2. Set Reserve Requirements: fractions of checking account balances that banks must maintain as currency reserves 3. Lend to Banks: makes short term loans to banks & charges them an interest rate called the discount rate 4. Provide for Check Collection: Fed handles withdrawing & receiving 5. Act as a fiscal agent for the government: financial services providers 6. Supervise Banks: personally auditing banks & ensuring compliance with financial regulations 7. Controlling $ Supply -Fed Serves as a Bankers Bank -12 Federal Reserve Banks are Quasi-Public -Quasi Public blends private ownership & public control

Functions of Money

1. Must act as a Medium of Exchange -facilitates trade, avoids complications of bartering (allows conversion) 2. Must act as a Unit of Account -money can (and is) used as a yardstick for measuring the relative worth of a variety of goods, services, & resources 3. Must act as Store of Value

How do we measure unemployment?

1. Not Viable for Labor force 2. Not in the labor force 3. The labor force

Aggregate Demand-Aggregate Supply Model (Why the AD Curve Downward Slope)

1. Real Balances Effect: a high price level, means public is "poorer", so they will spend less, which means a low demand 2. Interest Rate Effect: a high price level, means increase demand for money, increase interest rate which means less investment & consumption spending 3. Foreign Purchases Effect: high price level means US goods are more expensive, export less & import more (very low demand for domestic goods)

Non-Income Determinants of Consumption

1. Wealth: positive relationship 2. Expectations: positive relationship 3. Borrowing: positive relationship 4. Interest Rate: inverse relationship 5. Taxes: inverse relationship

APC (average propensity to consume)

= consumption/income → fraction of income that you spend

Law of Demand

As the price of a good falls, the quantity demanded for that good rises (ceteris paribus) --> negative relationship

Inflation Equation

CPI (present) - CPI (past) / CPI (past) *100

Monetary Policy

Consists of deliberate changes in the money supply to influence interest rates & thus the total level of spending in the economy

3 Examples of Sticky Prices

Consumers prefer stable prices (firms), firms have a fear about starting a price war, cost to changing prices (menu cost)

Problems & Complications of Monetary Policy

Cyclical Asymmetry, Liquidity Trap, Lags

Liquidity Trap

During a recession, an increase in banks' liquidity (increase banks' excess reserve) has little or no positive effect on lending, borrowing, investment, or aggregate demand

Expansionary Monetary Policy Results

Economy faces a recession Lower target for Federal Funds Rate Fed buy securities (or other tools to increase reserves) Expanded money supply Downward pressure on other interest rates

Where does Equilibrium occur?

Equilibrium occurs at price level where the amount of real output (GDP) demanded equals amount of real output supplied

Net Exports Equation (Xn)

Exports (X) - Imports (M)

Natural Rate of Unemployment Equation

Frictional Unemployment + Structural unemployment

Expenditures Approach Equation

GDP=C + I + G + Xn

Determinants of Investment Invest when...

Gain from investment ( r) > cost of investment (i) → If a firm expects to make more money per dollar borrowed than they have to pay back in interest, then investment is worth making → If cost of borrowing exceeds the expected return from borrowing the firm will not make the investment

Sticky Prices

Inflexible Prices

Problems with Fiscal Policy

Lags, Political Considerations, Future Policy Reversals, States & Local Government can offset Fiscal Policy, Crowding Out Effect

2 Main Points about Macro

Long Run Economic Growth & Short Run Fluctuations of Output & employment (Business cycles)

M2 Equation

M1 + Near Monies (highly liquid asset that is not currency but can be converted to currency very easily)

Lags

Monetary policy also faces a recognition lag & an operational lag, but because the Fed can decide & implement policy changes within days, it avoids the long administrative lag that hinders fiscal policy

Real GDP Equations

Nominal GDP/Price Index) * 100

4 Phases of Business Cycle

Peak, Recession, Trough, Growth

Restrictive (Contractionary) Monetary Policy Results

Periods of rising inflation Increases Federal funds rate Fed sells securities (or other tools to lower reserves) Money supply drops Increases other interest rates

Cyclical Asymmetry

The idea that monetary policy may be more successful in slowing expansions & controlling inflation than in extracting the economy from severe recession

Determinants of $ Demand Function (what shifts money demand)

Tool To Increase Sm To Decrease Sm Open Market Operations Buy Sell Reserve Ratio Decrease Increase Discount Rate Decrease Increase Interest on Reserves Decrease Increase

Supply Shocks

Unexpected change in supply (high or low demand)

Short Run Fluctuations of Output & Employment (business cycles)

Universal feature of all economies, economies alternative between growing (boom) & falling into recessions (bust)

Contractionary Fiscal Policy

Used during high inflation, causes a budget surplus, decreased spending or increased taxes

Expansionary Fiscal Policy

Used in recessions, causes a budget deficit, spending, or decreased taxes

Consumer Price Index (CPI)

Weighted average of goods purchased by a household, useful for calculating inflation (Price Index is ALWAYS equal to 100 in the base year)

Interest Rate Effect:

a high price level, means increase demand for money, increase interest rate which means less investment & consumption spending

Real Balances Effect:

a high price level, means public is "poorer", so they will spend less, which means a low demand

Real GDP

accounts for changing prices (current prices * base year prices)

Expenditures Approach

add up all spending on final goods & services in the economy within a year (purchased by 4 sectors - households, businesses, government, foreign buyers)

Nominal GDP

all about produced in an economy using prices of that good in the same year... total dollar value of all goods & services produced within a country using their current prices during the year that they were produced (can change from one year to next)

Ceteris Paribus

all else equal, if a variable other than price changes, it causes a change in the demand, which is a shift of the entire demand curve

Business Cycles

alternating rise (boom) & decline (bust) of economic activity which is usually measure by GDP

Crowding Out Effect

an expansionary fiscal policy may increase the interest rate & reduce investment spending (as well as consumption spending), thereby weakening or cancelling the stimulus of the expansionary policy

Expectations

anticipation of consumers & firms have about future economic conditions (someone's guess about how the economy is going to be operating during a period of growth)

Law of Supply

as price increases quantity supplied increases --> positive relationship

Price Floors

binding above equilibrium, creates a surplus ex-labor market

Price Ceiling

binding below equilibrium, creates a shortage ex- rent controls in NYC

If consumption is > DI

borrowing (dis-savings)

Examples of Exclusions from GDP

cash for birthday, social security payments, secondhand sales

Near Monies

certain highly liquid financial assets that do not function directly as currency , but can be readily converted into currency or checkable deposits

MPC (marginal propensity to consume)

change in consumption/change in disposable income → fraction of any change in income that is consumed

Determinants of AD Curve (things that shift AD curve)

change in price level changes the amount of real GDP demanded by the economy, other things equal → Increase in any of these will increase AD shift to right 1. Consumption Spending 2. Investment Spending 3. Government Spending 4. Net Export Spending

MPS (marginal propensity to save)

change in saving/change in disposable income

M1 Equation

currency & checkable deposits

Nominal GDP Equation

current output * current prices

Goal of Contractionary Fiscal Policy

decrease AD (control spending) to control inflation

Fiscal Policy

deliberate changes in government spending & tax collections designed to achieve full employment, control inflation, & encourage economic growth --> does NOT include all government spending

Long Run Economic Growth

determining how & why economies grow, understanding why economies growth allows for future growth

Saving Equation

disposable income - savings

Shortcomings of GDP

does not include non-market activities, does not account for improved product quality, environmental impacts, or if goods produced are actually good for society, underground economy, & does not include leisure

Inflation

general rise in prices - reduces purchasing power of $ -negative inflation is deflation and CAN happen

Foreign Purchases Effect:

high price level means US goods are more expensive, export less & import more (very low demand for domestic goods)

Disposable Income Equation

income - taxes

Increase in disposable income will lead to

increase in consumption

Cost Push Inflation

increases in per-unit production cost, reduces profits

Unemployment

measure of how active or "healthy" the labor markets are

Real Gross Domestic Product (GDP)

measures value of final goods & services produced within a country during a specific amount of time

Full Employment

no cyclical unemployment, frictional & structural unemployment, natural rate of unemployment goes along with this

Example of Supply Shock

oil rig breaks

Discretionary Fiscal Policy

part of government spending that must be actively enabled to occur

Non-Discretionary Fiscal Policy

part of government spending that will occur without any direct approval

Exclusions of GDP

purely financial transactions (purchases of stocks or bonds)

APS (average propensity to save)

saving/income

Example of Demand Shock

shock to wealth or assets

Income Approach

summing up all of the incomes that were derived from producing the economy's output of goods & services

Goal of Monetary Policy

to achieve & maintain price-level stability, full employment & economic growth .... Real interest rate can be thought of as the "price" of money

Goal of Expansionary Fiscal Policy

to increase AD & achieve full-employment GDP

GDP

total market value of all final goods & services produced within an economy in one year

Demand Shocks

unexpected change in demand (high or low demand)

Shocks

unexpected change in demand or supply (positive or negative) .... expecting one thing to happen but something else happens instead

Demand Pull Inflation

when total level of spending greatly exceeds output

What "Backs" the Money Supply

→ Acceptability: currency & checkable deposits are money because people accept them as money → Legal Tender: acceptability of paper money → Relative Scarcity: money derives its value from its scarcity relative to its ability to satisfy people →Money's purchasing power determines its value. High prices mean less purchasing power

AE Model: Changes to Inventories

→ Explains how changes in the level of spending can create business cycles →At full employment GDP, all available workers are fully employed so cannot increase production → When AE>Full Employment GDP: severe demand-pull inflation, nominal GDP increases, economy produces at full employment

Determinants of AS Curve

→ shows relationship between a nations price level & amount of real domestic output that firms in the economy produce 1. Change in Input Prices: Increase 2. Productivity: Positivity 3. Legal Environment: business taxes (inverse), subsidies (positive), government regulations (inverse)