Specialization: -Individuals and countries can be made better off if they will produce in what they have a comparative advantage and then trade with others for whatever else they want or need
Absolute and Comparative Advantage:
Absolute: -The producer that can produce the most output or requires the least amount of inputs Comparative: -The producer with the lowest opportunity cost - Countries should trade if they have a relatively lower opportunity cost - They should specialize in the good that is cheaper for them to produce
Distinguishing Input from Output: - An output problem presents the data as products produced given a set of resources. - An input problem presents the data as amount od resources needed to produce a fixed amount of output. -When identifying absolute advantage, input problems change the scenario from who can produce the most to who can produce a given product in a least amount of time and resources.
Foreign Exchange: - The buying and selling of currency - In order to purchase souvenirs in France, it is first necessary for Americans to sell their dollars and buy euros -Any transactions that occurs in the Balance of Payments necessities foreign exchange. -The exchange rate is determined in the foreign currency markets.
Changes in Exchange Rates: -Exchange rates are a function of the supply and demand for currency.
Exports and Imports: -The exchange rate is a determinant of both exports and imports -Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper thus reducing exports and increasing imports -Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively cheaper and foreign goods to be relatively more expensive; thus, increasing exports and reducing imports.
Balance of Payments: -Measure of money inflows and outflows between the U.S and the rest of the world. -Inflows are referred to as CREDITS -Outflows are referred to as DEBITS
Divided into 3 Accounts1) Current Account 2) Capital/ Financial Account 3) Official Reserves Account
Current Account: -Balance of Trade or Net Exports -Exports (-) Imports -Exports create a credit to the balance of payments -Imports create a debit to the balance of payments
Net foreign income is earned by U.S. owned foreign assets (-) income paid to the foreign held U.S. assets. Net Transfers are foreign Aids or a debit to the current account
Capital/ Financial Account: -The balance of Capital ownership -Includes the purchase of both real and financial assets. -Direct investment in the U.S. is a credit to the capital account -Direct invest by U.S firms/ individuals in a foreign country are debits to the capital account. -Purchase of foreign financial assets represents a debit to the capital account. -Purchase of domestic financial assets by foreigners represent a credit to the capital account.
Relationship between a Capital and Current Account: -They should zero each other out -That is... if the current account has a negative balance (deficit), then the capital account should then have a positive balance (surplus)
Official Reserves:-The foreign currency holdings of the U.S. Federal Reserve System -When there is a balance of payments surplus the Fed accumulates foreign currency and debits the balance of payments. -When there is a balance of payments deficit, the Fed depletes its reserves of foreign currency and credits BOP -The Official Reserves zero out the BOP
Supply- Side economics/ Reganomics: -trying to stimulate production of supply to spur output
1) Cut taxes & government regulations to increase incentives for business and individuals 2) Business invest and expand creating jobs 3) People work, save, and spend more.
Laffer Curve: -Depicts a theoretical relationship between tax rates and tax revenues
Criticisms of the Laffer Curve:
1) Empirical evidence suggests that the impact of the tax rates on incentives to work, save and invest are small. 2) Tax cuts also increase demand, which can feel inflation and demand impacts may exceed supply impacts. 3) Where the economy is actually located on the Laffer curve is difficult to determine.
Phillip's Curve: -An inverse relationship between unemployment and inflation. -As one increases, the other decreases -An increase in AD will cost price level and real output to increase, which increases inflation and reduces unemployment -Each point on the Philip's curve corresponds to a different level of output -Since wages are sticky, inflation changes move the points on the SRPC If inflation persists, and the expected rate of inflation rises, then the entire SRPC moves upward.
Stagflation: -When inflation and unemployment rise simultaneously, which results in an increase in input cost -Philip's curve shifts outward.
Supply Shocks: -Sudden large increase in resource costs. -If inflation expectations drop, due to new technology or efficiency, then the SPRC will move downward.
Long-Run: -LRPC occurs at the natural rate of unemployment -Represented by a vertical line -No trade-off between unemployment and inflation because the economy produces at the full employment output level. -Will only shift if LRAS shifts. -Increases in unemployment shifts LRPC to the right. -Decreases in unemployment shifts LRPC to the left. -Natural rate of unemployment is equal to frictional, structural and seasonal. -Major LRPC assumption is that more worker benefits create higher natural rates and fewer worker benefits create lower natural rates.
Misery Index: -A combination of unemployment and inflation in any given year. -Single- digit misery = good.
Loanable Funds Market: - Private sector supply
and demand for loans
- Brings together savers and borrowers - Shoes effect on Real
interest Rate
Demand:
-inverse relationship between real interest rate and quantity of loans demanded Supply:
-Direct relationship between real interest rate and quantity of loans supplied
-NOT SAME AS MONEY MARKET
The Tools of Monetary
Policy and Shifters of MS- 04/03/17
Tools of Monetary Policy:
1) Reserve Requirements
2) Open Market Operation
3) Discount Rate
Reserve Requirement:
-amount that
must be kept in vaults
-FED sets the percent banks must hold
1) If there is a recession, what should
FED do to the RRR?
Decrease the reserve ratio
-Banks hold less money and have more excess reserves
-Banks create more money by loaning out excess reserves
-MS increases, i decreases, AD increases
2) If there is an inflation, what should
the FED do to the RRR?
Increase the reserve ratio
-Banks hold more money and have less ER
-Banks create
less money
-MS decreases, i increases, AD decreases
Open Market Operation:
-FED buys/sells bonds
-most important and widely used monetary tool
-If fed buys bonds, MS increases
-If FED sells bonds, MS decreases
Discount Rates
-interest rate that FED charges Commercial banks for short term loans
Federal Fund Rate:
-interest rate that banks charge one another of overnight loans
Prime Rate:
-interest rate banks charge their most credit worthy customers
- A single bank
can create $ by the amount of its excess reserves
- The banking system as a whole can create money by a multiple of the excess
reserves
- MM * ER = expansion of money
- MM = 1/RRR
New vs. Existing Money
- If the initial deposit in a bank comes from the FED or bank purchase of a
bond or other money of the initial deposit in a bank comes from the FED or bank
purchase of a bond or other money out of circulation ( buried treasure) the
deposit immediately increases the money supply
-The deposit then leads to further expansion of the money supply through the
money creation process
-The total change in MS if initial deposit is new money = Deposit + money
created by banking system.
-If a deposit in a bank is existing money (already counted in M1, currency or
checks) depositing the amount does NOT change the MS immediately because it is
already counted in it
-Existing currecy deposited into a checking account changed only the
composition of the money supply from coins/paper money to checking account
deposits
-Total
change in MS in deposit is existing money = banking system created money only
-Demand for money has an inverse relationship between
nominal interest rates and the quality of money demanded
1) What happens to the quantity demanded
of the money when interest rates increase?
-Quantity demanded falls because individuals would prefer to have interest
earning assets instead of borrowed liabilities 2) What happens to the quantity demanded
when interest rates decrease?
-Quantity demanded increase
-There is no incentive to convert cash into interest earning assets.
The Determinants for Money
1) Changes in price level
2) Changes in income
3) Changes in taxation that affects investment
Increasing the money supply
- increase money supply à Decreases interest rates à
Increases investment à Increases AD
How
Banks Create Money?
Fractional Reserve System
- Demand deposits are created
- The process in which banks hold a small portion of their deposits in reserves
and they loan out the excess
- Banks keep cash on hand (RR) to meet depositors needs
- Banks must keep reserve deposits in their vaults or at their district FED
- Total Reserves ( total funds held by the bank) equals to Required Reserves +
Excess Reserves
- Banks can only lend out their excess reserves
