ABSOLUTE AND COMPARATIVE ADVANTAGE

Absolute Advantage

-Individual- exists when a person can produce more of a certain good/service than someone else in the same amount of time (or can produce a good using the least amount of resources).

National- exists when a country can produce more a good/service than another country can in the same time period.

Comparative Advantage
A person or a nation has a comparative advantage when it can produce the product at alower domestic opportunity cost than can a trading partner.

Examples of output problems
1. Words per minute.
2. Miles per gallons.
3. Tons per acre
4. Apples per tree
5. Televisions produced per hour

Examples of input problems
1. Number of hours to do a job.
2. Number of acres to feed a horse
3. Number of gallons of paint to paint a house.

Specialization and trade
-Gains from trade are based on comparative advantage, not absolute advantage.

MECHANICS OF THE FOREIGN EXCHANGE

-The buying and selling of currency.
-Any transaction that occurs in the balance of payments necessitates foreign exchange.
-The exchange rate (e) is determined in the foreign currency markets.

Changes in exchange rates

Exchange rates (e) are a function of the supply and demand for currency.

An increase in the supply of a currency will decrease the exchange rate of a currency.

A decrease in supply of a currency will increase the exchange rate of a currency.

An increase in demand for a currency will increase the exchange rate of a currency.

A decrease in demand for a currency will decrease the exchange rate of a currency

Appreciation and depreciation

Appreciation of a currency occurs when the exchange rate of that currency increases. (e increases)
Depreciation of a currency occurs when the exchange rate of that currency decreases (e decreases)

Determinants of Exchange rate
1. Consumer tastes (buyers taste)

2. Relative income

3. Relative price level

4. Speculation

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 more expensive, thus increasing exports and reducing imports.

As two currencies trade:
1. One supply line will change; the other demand line will change.

2. They will move in the same direction.

3. One currency will appreciate, the other will depreciate.

Flexible rate
Based on the supply and demand of that currency versus the other currency. It is very sensitive to the business cycle and it provides options for investment.

Fixed rates
It is based on a countries willingness to distribute currency and to control the amount

UNIT 7- BALANCE OF PAYMENTS

-Measures of money inflows and outflows between the united states and the rest of the world (ROW).

-Inflows are referred to as credits-
-Outflows are referred to as debits-


The balance of payment is divided into three accounts:
1. Current account

2. Capital/financial account

3. Official reserves account


Double entry book keeping
-Every transaction in the balance of payments is recorded twice in accordance

Current account

Balance of trade or Net exports-Exports of goods/services- import of goods/services.
-Exports create a credit to the balance of payments.
-Imports create a debit to the balance of payments.

Net foreign income
- Income earned by the U.S. owned foreign assets
-Interest payments on U.S. owned foreign assets- Interest payments on German-owned U.S treasury bonds.

Net transfers (tend to be Unilateral).
-Foreign aid- a debit to the current account.
-Example- Mexican migrant worker sends money to family.

Capital / Financial Aid
-The balance of capital ownership.
-Includes the purchase of both real and financial asset


Direct investment in the United States is a credit to the capital account.
-For example the Toyota company in San Antonio


Direct investment by United States firms/individuals in a foreign country are a debit to the capital account.
-Intel factory construction in Germany


Purchase of foreign financial assets represents a Debit to the capital account.
-Warren buffets buys stock in Petrochina.


Purchase of domestic financial assets by foreigners represents acredit to the capital account.
-The UAE sovereign wealth fund purchases a large stake in the NASDAQ.

Relationship between current and capital account
-The current account and the capital account 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. fed.
-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 the balance of payments.


Active v. passive official reserves
-The U.S. is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.
-The People's Republic of China is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate w/ the United States.


Formulas

1. Balance of trade:
- Good exports + goods imports

2. Balance on goods & services:
- Goods exports + service exports + goods imports + service imports.

3. Current Account:
- Balance on goods and services + net investment + net transfers

4. Capital account:
- Foreign purchases + domestic purchases.

UNIT 6 PRODUCTIVITY AND ECONOMIC GROWTH

Economic Growth
-sustained increase in real GDP over time as well as per capita over time
-growth leads to greater prosperity for society
-lessons burden of scarcity


Conditions for Growth
•Rule of Law
•Sound Legal and Economic Institutions
•Economic Freedom
•Respect for Private Property


•Political & Economic Stability
–Low Inflationary Expectations
•Willingness to sacrifice current consumption in order to grow

•Saving

•Trade


Physical capital
-tools, machinery, and factories
-physical capital is a product of investment
-it takes capital to make capital


Technology and Productivity
-research and development innovation and invention yield increase in tech
-more tech= more productivity
-more productivity=economic growth


Human Capital
-people are a country's most important resource
-education
-economic freedom
-incentives
-clean water
-stable food supply


Hindrances to growth
-economic and political stability
-absence of the rule of law
-diminished private property rights
-negative incentives
-lack of savings
excess current consumption
-failure to maintain existing capital
-crowding out of investment

A.S ANALYSIS

In macroeconomics, this is the period in which wages (and other input prices) remain fixed as price level increases or decreases.

Long Run Aggregate Supply
-Period of time in which wages have become fully responsive to changes in price level.

Effects over Short-Run
-In the short run, price level changes allow for companies to exceed normal outputs and hire more workers because profits are increasing while wages remain constant.
-In the long run, wages will adjust to the price level and previous output levels will adjust accordingly.

Equilibrium in the Extended Model
-The long run AS Curve is represented with a vertical line at full employment level of real GDP.

Demand Pull Inflation
-Demand pull- prices increases based on an increase in aggregate demand.
-In the short run, demand pull will drive up prices, and increase production.
-In the long run, increases in aggregate demand will eventually return to previous levels.

Cost push & the Extended Model
-Cost push inflation arises from factors that will increase per unit costs such as increases in the price of a key resource.

Dilemma for the Government
-In an effort to fight cost-push, the government can react.
-Action such as spending by the government could begin an inflationary spiral.
-No action however could lead to a recession by keeping production and employment levels declining.

FOREIGN EXCHANGE MARKET

-buying and selling of currency

-any transaction that occurs in the balance of payments necessitates foreign exchange

-the exchange rate is determined in the foreign currency markets

Changes in exchnage rates

-exchange rates are a function of the supply and demand for currency

-/\ supply of currency will \/ exchange rate

-\/ supply of currency will /\ echange rate

-/\ demand for curency will /\ exchange rate

-\/ demand for currency will \/ exchange rate

Appreciation and depreciation

-appreciation will happen when /\ exchange rate 

-depreciation will happen when \/ exchange rate

Exchange rate determinants

-consumer taste

-relative income

-relative price level

-speculation 

Exports and imports

-the exchange rate is a determinant of both exports and imports

-appreciation of the dollar causes American goods to be relativley more expencive 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 more expencive thus increasing exports and reducing imports

BALANCE OF PAYMENTS

Measure of money inflows and outflows between US and the rest of the world

-inflows are referred to as credits

-outflows are reffered to as debits

Current account

-Balance of trade or net exports

.exports of goods/services-inports of goods/services

.exports create a credit to the balance of payments

.imports create a debit to the balance of payments

-Net foreign income

.income earned by the us owed foreing assets-income paid to foreign held U.S assets

-Net transfers

.foreign aid-> a debit to current account

Capital financial account

-Balance of capital ownership

-includes the purchase of both real and financial assets

-direct investment in the united states is a credit to the capital account

-direct investment by U.S firms/individuals in a foreign country are debits the capital account

-purchase of foreign financial assets represents a debit to the capital account

-purchase of domestic fiancial assets by foreigners representatives a credit ro the capital account

Relationship between current and capital

-they must be equal to zero

-that is if current has a negative balance, then the capital account should then have a positive balance 

Official reserve account

-the foreign currency holdings of the United States federal reserve system

-when there is a balance of payments surpls the fed accumulates foreign currency and debits the balance of payments

-when there is a balance of payments defitcit the fed depletes its reserves kf foreign currency and credits the balance lf payments 

-OR will zero out balance of payments

Active vs passive official reserve

-the united states is passive in its use of official reserves it does not seek to manipulaye the dollar exchange ratel

SUPPLY SIDE ECONOMICS

-changes AS and not AD

-Determins the level of inflation, Unemployment rates and economic growth

-supply side economist support policys that promote GDP growth by arguing that high marginal tax rates along witht he current system of transfer payments such as unemployment compensations or welfare programs, provide disensentives to save, work, innovate and undertake entrepreural ventures

-lower marginal tax rates induce more work thus causing AS to increase

-lower marginal tax rates also make leasure more expencive and work more attractive

Incentive to save & invest

1. High marginal tax rates reduce the rewards for savings and investments

2. Consumption might increase but investment depends upon savings

3. Lower marginal tax rates encourage savings and investment

Laffer curve 

-theoretical relationships between tax rates and government revenue

-as tax rates increase from zero, government revenues increase from zero to some maximum level and then decline

Criticism

-research suggests that impact of tax rate on incentives to work, save, and invest are small

-tax cuts also increase demand which can fuel inflation and demand can exceed supply

-where the economy is actualy located on the curve is difficult to determine

FLATION

Inflation

-is the general rise in price level

Deflation

-general decline in price level

Disinflation

-decrease in the rate of inflation over time

Stagflation

-unemployement and inflation increasing at the same time

THE PHILLIPS CURVE

Long run Phillips curve

-because the lrpc exists at the natural rate of unemployment (Un) structural changes in the economy that affect Un will also cause the lrpc to shift

-increase in Un will shift lrpc ->

-decrease in Un will shift lrpc <-

The Short-Run Phillips Curve
-SRPC has a trade-off between inflation and unemployment (when one increases the other decreases). (inverse relationship)

LRPC: There is no trade off between inflation and unemployment.

1. The economy produces at the full employment output level.
2.It is represented by a vertical line.
3. It occurs at the natural rate of unemployment.

-Natural unemployment rate (NRU)= Frictional +Structural +Seasonal

-Full employment = 4-5%

-LRAS shifters also shifts LRPC.

-The major LRPC assumption is that more worker benefits create higher natural rates and fewer worker benefits create lower natural rates.

Major lrpc 

More worker benefits create higher rates

Few worker benefits creates lower rates

Supply shocks

-caused by rapid and significant increases in resource cost

-causes SRAS to shift

Example

-oil price

-baby boom

-trade pact

Misery index

-combination of Un and inflation in any given year

-single digit misery is good

FINAL NOTES FOR UNIT 4

When a customer deposits cash or withdraws cash from their demand deposits acct, it has not effect on money supply

Single bank
- loan money Excess Reserves (ER)

Banking system
- ER X multiplier(total money supply)

It only changes:

1) the money composition of the money

2) excess reserves

3) required reserves

When the fed buys or sells bonds ER is created

MONETARY POLICY

1. Reserve requirement 

- only a small percent of your bank deposit is in the safe. The rest of your money has been loaned out "fractional reserve banking" .

-the FED sets amount the banks .must hold.

-the reserve requirement reserve ration is the % if deposites that banks must hold in reserve and not loan out.

-when the FED increases the money supply it increases the amount of money held in money deposits.

If there is a recession rr=decrease

Decrease

-banks hold less money and have more excess reserves

-banks creates more money by loaning out excess

-money supply increases intrest rates fall, AD goes up

If the theres is inflation rr=increase

Increase

-banks hold money and have less excess reserve

-banks creates less money

-money supply decrease, interest rates up, AD down

2. Discount rate 

-The discount rate is the interest rate that the FED charges commercial banks

To increase the money supply the FED should decrease the discount rate

To decrease the money supply the FED should increase the discount rate

3. Open money operations

-the FED buys / sells government bonds (securities)

-this is the most important and widely used monetary supply

Increase money supply the FED should buy government securities

Decrease money supply the FED should sell government securities

Federal fund rate- FDIC member banks loan each other overnight funds 

Prime rate- Intrest rate that banks give to their most credit worthy customers

FEDERAL BANKS

Federal Reserve Banks
Functions
-Uses paper $
-Set reserve requirement and holds bank reserves
-Lends $ to banks and charges interest
-Check-clear service for banks
-Personal bank for government
-Supervises member banks
-Controls money supply in the economy

Reserve Requirement 

- Fed needs banks to always have $ to meet demand

Amount = Reserve Ratio - % of DD locked to bank

GRAPHS AND BANKING SYSTEM

Demand Graph

Demand for money increase inverse w/nominal interest rate and quantity of money (Q decreases, I increases and vice versa)

Shifters: Change in
-PL
-Income
-in taxation after investment

Money Supply
Affects AD when

Increased: -> r down, Ig up, AD up (Vertical)
Decreases - Goes Left: MS down, r up, Ig down, AD down

Financial Sector
Fin. Assets - Stocks and bonds provide expected future benefits
Benefits owner from issuer of asset meeting certain obligations
Fin. Liabilities - Incurred by issuer of fin. asset to stand behind issued asset
Interest Rate - $ paid to use fin. asset
Stocks - Fin. asset that represent ownership in a company
Bonds - Promise to pay $ and interest in the future

Banks
Fin. Intermediary - use liquid assets to fund investments of borrowers -> Fractional Reserve Banking
Liquid assets include currency in bank vaults and bank reserves
Banks create money by lending out deposits that are used multiple times
When a customer deposits cash or withdraws cash from their demand deposit account, it has NO EFFECT ON THE MONEY SUPPLY

It only changes...
-The composition of money
-Excess Reserves
-Required Reserves
-Changes in Money Supply for....
-Single Bank
-Loan money from ER
-Banking System
-ER x Money multiplier (1/RR) -> Total Money Supply
-When the FED buys or sells bonds, ER is created

Basic Accounting Review

T-Account (Balance Sheet) - Lists assets and liabilities

Assets (Amounts owned) - Items claimed legally by bank; use of funds by fin. intermediary

Included in assets

-Required Reserves - % of DD in vault
-Excess Reserves - Remaining % of DD used for loans
-Property - Statement of a bank's property values
-Securities or Bonds - Previously purchased bonds held by the banks as investments
-Loans - Previously loaned funds now owed back to the bank
-Liabilities (Amounts owed) - Legal claims against a bank; sources of funds.

Included in liabilities
Demand Deposits - Cash deposits from the public to the bank
Part of MS if from person's cash holdings
Becomes new $ if from a bond -> MS up
Owner's equity or stock shares - Values of the bank stocks as held by the public
DD = RR + ER

Money

Uses of money

Medium of exchange

-borrow and trade 

Unit of account

-it establishes economic value 

-(cake for lessons)

Store of value

-money holds it value over a period of time where as products may not

Types of money

Commodity

-it gets its value from the type of material from which it is made

-(gold and silver coins)

Representative money

-it is paper money backed by somthing tangible that gives it value

Fiat money

-Money because government says so

Characteristics of money

1. Divisible

2. Portable

3. Uniform

4. Acceptable

5. Scarce

6. Durable

Money supply

M1 Money

-75% of money from circulation

-most liquid (easy to covert to cash)

Currency 

.Checkable deposits

.Demand deposited

.Travelers check

M2 Money

-M1 money, Savings account, and Deposits held by banks outside of the U.S

M3 Money

-M2 money and Cirtificate of Deposited (C.D)

-C.D: pull money by X ammount of time

Time value of money

Is a dollar today worth more than a dollar tomorrow? Opportunity cost and inflation reason for charging and paying Intrest

Let V = future value of money

      P= present value of money

      r= real intrest rate (nominal - inflation rate expressed as a decimal)

     n= years

      k= number of times intrest is credited per year

Simple intrest formula

V=(1+r)^n • p

Compound intrest rate

V= (1+(r/k)^nk • p

Demand for money has an inverse relationship between nominal interest rates  and the quantity of money demanded

What happens when quantity of money when interest rates increase?

-quantity demanded falls because individuals would prefer to have interest earning assets instead kf borrowed liabilities 

What happens to the quantity demanded when interest rate decrease?

-quantity demanded increases. There in no incentive to convert cash into interest earning assets

Financial sector

Financial asset- something that you own

Financial liability -something that you owe

Interest rate -cost of borrowing money

Stocks-share of a company

Bonds- lend money to the government and how much the owe you with intrest

What banks do

A bank is a financial intermediary

-uses liquid assets (i.e bank deposits) to finance the investments of borrowers

fractional reserve banking 

-A system in which depository institutions hold liquid assets less than the amount of deposites 

Can take form of

-currency in bank vault

-bank reserves-deposites held at the federal reserve

T account (balance sheet)

-statements of assets and liabilitys

Assets

-items to which the bank holds legal claim

-the uses of funds by financial intermediaries 

Liabilities

-the legal claims against a bank

-the sources of finds fir fianacial intermediary 

MONETARY POLICY

AP Macroeconomics Unit 4 blog videos

Part 1
- The 3 main types of money are Commodity money, which means good for good (cow for flour), the second type is Representative money, which uses gold or silver (gold standard), the last type of money which is the most current type is Fiat money which is money that is accepted by everyone and backed by the government. Money is known as a medium of exchange in which case every one accepts it across the country. Money is also a store of value, which means the money you put in will be the same amount as when you take it out. Money is a unit of account, that implies the price is worth the quantity in which you buy it at.

Part 3- Money market graphs are labeled by the interest rate being the Y-axis and Commodity being the X-axis. The graph will slope upward is the price is low and the demand is high and will slope downward when its the exact opposite. The graph is vertical because its not varying and is fixed by the Fed. The MMG will shift left or right depending on the demand for money unless changed by the Fed, the only way to change the supply of money is for the government increase or decrease during inflation or recession.

Part 4
- The two options to use during money policy is expansionary money (easy $) and Contractionary money (tight $). The first part is Reserve requirement In which they lower money supply during expansionary and raise with contractionary. With Discount rate the Fed will lower during expansionary and raise with contractionary. With expansionary the Fed will buy bonds and with contractionary the Fed will sell bonds.

Part 7
- With the Loanable Funds graph Price is on the Y-axis and Quantity of funds is on the X-axis. Demand for loanable funds is downward sloping, and Supply for loanable funds is sloping upwards. Supply for loanable funds is dependent on savings and it will increase when people have an incentive to spend money and decrease when people wants to save. If the government is running a deficit, that means the government is demanding money and the demand for loanable funds will increase.

Part 8
- Money creation process consists of two parts first one being money multiplier and second is multiple deposit expansion. During the money creation process governments create money by making loans.This increase is from the Multiple deposit expansion which affects the entire banking system but it is only a potential increase.For example the Reserve Requirement is 20% and the loan amount is $500, the total created is $2500 using (1/RR X loans)

Part 9
- When comparing MMG, LFG, and AD-AS curve graph they all correlate one what or another typically if one shifts to the right all of them shifts to the right. Lets say that in the MMG the government they increase the demand in money (which shifts to the right), when looking at LFG which also increase the quantity in loanable funds (shits the the right) and in the AD-AS graph the AD increases (also shifting to the right). The change in the supply of money is equal to the change in the price of money. Fisher effect says that if price increases then the other supply of money increases or vice versa.

FISCAL POLICY

-changes in the expenditures or tax revenues if the federal government

-2 tools of fiscal policy

.taxes- government  Can increase or decrease taxes

.spending- government can increase or decrease taxes

Deficits, Surplus, and Debt

Balanced budget
- Revenues = Expenditures

Budget deficit
- Revenues < Expenditures

Budget surplus
- Revenues > Expenditures

Government debt- 

-sum of all deficits - sum of all surpluses 

Government must borrow money when it runs a budget deficit

Government borrows from:

-individuals 

-corporations

-financial institutions 

-foreign entities or foreign governments

Discretionary fiscal policy (action)

-expansionary fp- think deficit

-contractionary fp- think surplus

Non-discretionary fiscal policy (no action)

Discretionary 

-increasing or decreasing government spending and/or taxes in order to return the economy to full employment directional policy involves policy makes doing fiscal policy to response to on economic problem

Automatic

-unemployment compensation & marginal tax rates are examples of automatic policies that help mitigate the effects of recession and inflation automatic fiscal policy takes place without policy makers having to respond to current economic problem

Expansionary fiscal policy

-combat recession

-^ govt spending ¥ lower taxes

Contractionary fiscal policy

-Combat inflation

-¥ govt spending ^ taxes

Automatic or built in stabilizers

.anything that increases the governments budget deficit during a recession and increases its budget surplus during inflation _without requiring explicit action by policy makers_

Ex. Transfer payments 

(ss, medicaid/care, unemployment, veterans benefits.)

progressive tax system- average tax rate (tax revenue/GDP) 

Proportional tax system- average tax rate constant as GDP changes

Regressive tax system- average tax rate falls with GDP

CONSUMPTION AND SAVINGS MULTIPLIERS

Disposable Income
-The income after taxes [Gross - Taxes]
-Consume or save (Spend or not spend)
-Consumption - Restricted by DI & propensity to save
-If DI = 0, autonomous consumption and dissaving

Saving - Restricted by DI & propensity to consume
If DI = 0, no saving


APC/APS = Average propensity to consume/save
-APC + APC = 1
1 - APC = APS
1 - APS = APC
-APS or when APC > 1 -> Dissaving

Multipliers
MPC + MPS = 1
MPC = 1- MPS
MPS = 1 - MPC

MPC
-Marginal ... Fraction of any change in DI consumed
(Change in Consumption/Change in DI)

MPS
-Fraction of DI saved
(Change in Saving/Change in DI)

Spending Multiplier Effect
-Initial change in spending; causes larger change in AS or AD
(1/(1-MPC)) or 1/MPS
-Multiplier = (Change in AD/Change in C, Ig, G, or Xn)
-Positive is increase; Negative is decrease

Tax Multiplier
-Reverse multiplier because it leaves circular flow
-Tax cut is positive because money enters circular flow
-Always negative
-(MPC/(1-MPC)) or -(MPC/MPS)
-Multiplier = (Change in AD/Change in C, Ig, G, or Xn)

CLASSICAL

Followers
-Adam Smith
-J.B. Say
-David Ricard
-Alfred Marshall

Say's Law

-Supply creates own demand
-Production = Income = Spending
-Underspending unlikely
-Whatever output produced will be demanded

Savings and investment
-Savings = Investment income
-Savings (Leakage) = Investment (Injection)

Loan able Funds Market

Wage/Price Flexibility
-Downward

Supply Curve
-Vertical

Output and Employment
-Determined by AS

Unemployment
-Rarely exists because of wage/price flexibility
-Cause: external (war)

Aggregate Demand
-Determines PL
-Stable if money supply is stable

Basic equation

-MV = PQ
-1965 - 1972

Role of government
-Monetary policy maintains steady money supply
-Laissez-faire is best
-Self regulating economy

Inflation
-Too much money

How long the short run is
-Short time

Emphasis today
-Microeconomics

Other
-Competition is good
-Invisible Hand
-Long run - Balance @ FE
-Trickle-Down effect - Help rich 1st, everyone else 2nd

KEYNESIAN

Followers
-J.B. Keynes

Say's Law
Depressions refute Say's Law
--Demand creates own supply
-Under spending persists

Savings and investments

-Savings not equal to investment
-Different motivations

Savings
-Future needs
-Precaution
-Habit
-Income level
-Interest rate

Investment
-Interest rate
-Rate of profit
-Expectations

Loan able Funds Market
-Investment from savings, cash, checking accounts
-Lending creates money -> Supply of money increases
-Inflation and unemployment are unstable

Wage/price inflexibility
-Prices and wages inflexible downward
-Ratchet effect

Supply curve

-Horizontal

Output and Employment
-Determined by AD

Unemployment
-Usually exists
-Causes:
-External (war)
-Internal (Savings not equal to investment

Aggregate Demand-Changes due to determinants
-Unstable even if money supply is stable due to fluctuations in investment spending

Basic equation
-C + Ig + G + Xn
-1973 - Present

Role of Government
-Fiscal Policy - Tax and spend
-Active government
-Economy is not self regulating

Inflation
Too much demand

How long the short run is

Long time

Emphasis Today
Macroeconomics

Other-
Flawed competition
AD is key; not AS
Leaks + Savings = Recession
Ratchet effects and Sticky Wages block Say's Law
We are doomed in the long run

INTEREST RATE AND INVESTMENT DEMAND

Investment

Money spend or expenditures on:

-New plants (factories)

-Capital equipment (machinery)

-Technology ( hardware and software)

-New homes

-Inventories (goods sold by producers)

Investment decisions

-cost / benefit analysis 

Determination of benefits

-expected rate of return

Count the cost

-interest costs

Amount of investment they undertake

-compare expected rate of return to interest cost

--if expected return > interest cost, then invest

--if expected return < interest cost, then do not invest

Real v Nominal

Difference is the observable rate kf interest. Rate subtracts out inflation (€%)

R% = i% - €% 

R = real interest rate

i = nominal interest rate

Pie= inflation rate

What determines the cost of an investment decision

-the real interest rate (r%)

Investment demand curve

Shape of investment demand curve

-downward sloping

Why?

-when interest rate are high, fewer investment are profitable; when interest rates are low, more investment are profitable

Shifts in investment demand (ID)

-cost of production

.higher cost shift ID <

.Lower cost shift ID >

-business taxes

.Higher taxes shift ID <

.lower taxes shift ID >

-technological change

.new tech shift ID >

.lack of tech shift ID <

-Stock of capital 

.If low capital then ID >

.If high on capital then ID <

-Expectations

.If positive then ID  >

.If Negative then ID <

WAGES

Nominal wages - amount of money received by a worker per unit of time

Real wages - amount of goods and services a worker can purchase with their nominal wage

Sticky wages - it is the nominal wage level that is set according to an initial price level and it does not vary due to labor contracts or other restrictions 

Implications recessions - output depends on changes in employment level 

Implication intermediate - output depends on changes in price and employment level

Implication inflation- output is independent of changes in the price level 

AGGREGATE SUPPLY

-the level of real GDP (gdp r) that firms will produce at each price level (PL)

Long run v Short run

Long run

-period of time where input prices are completely flexible and adjust to changes in the price level

-in the long run the level of real GDP supplied is independent of price-level

Short run

-period of time where input prices are stucky and do not adjust to changes jn the price level

-in the short run the level of real GDP supplied is directly realted to the price-level

Long run aggregate supply (LRAS) 

-The LRAS marks the level full employment in the economy

-Because input prices are completely flexible in the long run, changes in theprice level do not change firms' level of output. That means that LRAS is verticleat the economy's level of full employment.

Changes in SRAS

-increase in sras is seen as a shift to the right SRAS->

A decrease in sras is seen as a shift to the left SRAS <-

The key unit to understanding shifts ij sras is per unit cost of production 

-Per unit production cost= total input cost / total output-

Determinants of SRAS

INPUT PRICES

Domestic resource prices

.wages (75% of all buisness costs)

.cost of capital

.raw materials

Foreign reource prices

Market Power

Increase in resources prices = SRAS <-

PRODUCTIVITY

productivity = total output / total inputs

More productivity = lower unit production cost = SRAS ->

Lower Productivity = higher unit production cost = SRAS <-

LEGAL INSITUTIONAL ENVIROMENT

-Taxes and subsidies-

-Taxes ($ to govt) on buisness increase per unit production cost = SRAS <-

-Subsidies ($ from govt) to business reduce per unit production cost = SRAS ->

GOVERNMENT REGULATION

-government regulation creates a cost of compliance = SRAS <-

-Degregation reduces compliance costs

= SRAS ->

Full employment 

-full employment equilibrium exists where AD intersects SRAS & LRAS at the same points

Recessionary gap

-a ressionary gap exsts when equilibrium occurs below full employment output

Inflationary gap

-exists when equilibrium occurs beyond full employment output

AGGREGATE DEMAND

Aggregate demand curve

(Insert graph)

AD is the demand by consumers, businesses, governments, and foreign countries

What definitely doesn't shift the curve?

-changes in the price level cause a move along the curve

Why does AD downward sloping

1. REAL BALANCE EFFECT

-higher power levels reduce the purchasing power of money

-the decreases the quantity of expenditures 

-lower price levels increase purchasing power and increase expenditures

2. INTEREST RATE EFFECT

- when the price level increases, lenders need to charge higher interest rate to get a REAL on their loans

-Higher interest rates discourage consumer spending and buisness investment

3. FOREIGN TRADE EFFECT

-When U.S price level rises, foreign buyers purchase fewer U.S goods and Americans buy foreign goods

-Exports fall and import rise causing real GDP demanded to fall. (Xn, Decreases)

SHIFTERS OF AGGREGATE DEMAND

GDP = C + 1 + G + Xn

-change in C, Ig, G and Xn

-Multiplier effect that produces a greater change than the originial change in the 4 components

Increases in AD = AD ->

Decreases in AD = AD <-

CONSUMPTION

Household is effected by

Consumer wealth

-more wealth = more spending (AD >)

-less wealth = less spending (AD <)

Consumer expectations

- positive expectations = more spending (AD >)

-negative expectations = less spending (AD <)

Household indebtedness

-more debt = less spending (AD <)

-less debt = mores spending (AD >)

Taxes

- less taxes = more spending (AD >)

-more taxes = less spending (AD <)

Gross private investment

Investment spending is sensitive to

Real interest rate

-lower real interest rate = (less AD >)

-higher real interest rate = (less AD <)

Expected returns

-Higher Expected Returns= more investment (AD >)

-Lower Expected Returns = less investment ( AD <)

-Expected Returns are influenced by

-expectations of future probability 

-technology

-degree If excess capacity [Existing stock of capital]

-Business Taxes

Government spending 

-more government spending (AD >)

-Less government spending (AD <)

Net exports

-sensitive to 

Exchange rates (international value of $)

-Strong $ = more imports and fewer exports (AD <)

-Weak $ = fewer imports and more exports (AD >)

Relative income

-strong foreign countries = more exports = (AD >)

-weak foreign countries = more exports = ( AD <)