Unit 7 Absolute and Comparative Advantage (5-11-16)

Unit 7

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 a lower 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.

Unit 7 Mechanics of the Foreign Exchange (FOREX) [5-3-16]

Unit 7

Mechanics of the Foreign Exchange (FOREX)

•  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 The Balance of Payments (4-27-16)

Unit 7

The 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 Account

·         The 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.

-          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 a credit 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 Economic Growth and Productivity (4-11-16)

Unit 6

Economic Growth and Productivity

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

credit to:http://lexxxeconomics.blogspot.com/2009_10_01_archive.html

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 

Unit 5 The Phillips Curve (4-8-16) & Inflation (4-11-16)

Unit 5

The Phillips Curve & Inflation

side note - misery index

The Long-Run Phillips Curve

• Measures unemployment and inflation.

• Note: Natural rate of unemployment is held constant.

• Because the Long-Run Phillips Curve exist at the natural rate of unemployment, structural changes in the economy that affect unemployment will also cause the LRPC to shift.

• Increases in unemployment will shift LRPC to the right
• Decreases in unemployment will shift LRPC to the left.

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 tradeoff 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.

The misery index:  A combination of inflation and unemployment in any given year.

• Single digit misery is good.

Inflation:

It is the general rise in the price level

Deflation:

A general decline in the price level

Disinflation:

Decrease in the rate of inflation over time

Stagflation:

Unemployment and inflation increasing at the same time.

Unit 5 Extending the Analysis of Aggregate Supply (4-7-16)

Unit 5

Extending the Analysis of AS

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.

Unit 4 - Money (3-29-16)

Fiscal vs Monetary Policy

From the worksheet  "Countercyclical Policies:Keynesian Fiscal Policy vs Monetary Policy" and notes 

-Note: Check ^ for full notes (this is more or less Abbreviated) [side note]-wording is key

 In the early 21st century, here in the USA, an efficient, "full employment" economy will probably have:

• Annual unemployment rate 4-5%
• Annual inflation rate 2-3%

If the economy goes into a recession:

• The real GDP decreases for at least 6 months
• Unemployment rate increases to 6% or more
• Inflation rate decreases to 2% or less

If Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the recession, then:

• The policy will try to improve C or G (parts of AD)
• Congress will cut federal taxes
• Congress will increase job and spending programs
• The federal budget will probably create a deficit
• Due to changes in Money Demand, interest rates will increase (Crowding out might occur, but Keynesians don't care)

If the Federal Reserve employs Monetary Policy options to slow/stop the recession, then: 

• The policy will target improvement in Ig (part of AD)
• The Fed will target a lower Fed Fund Rate
• The Fed can lower the discount rate
• The Fed can buy bonds (Open Market Operations)
• The Fed can (theoretically) lower the reserve requirement, but probably won't because it is too complex for the banks.
• These Fed policies will lower the interest rates through changes in the Money Supply
• These options should increase Ig

If the economy suffers from too much demand-pull inflation or cost-push inflation, then:

• The unemployment rate will go to 4% or less 
• The inflation rate will probably go to 4% or more

If Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the inflation problems, then: 

• The policy will try to decrease C or G (parts of AD)
• Congress will increase federal taxes
• Congress will decrease job and spending programs
• The federal budget will probably create a surplus
• Due to changes in Money Demand, interest rates will decrease

If the Federal Reserve employs Monetary Policy options to slow/stop the inflation problems, then:

• The policy will target decreases in Ig (part of AD)
• The Fed will target a increased Fed Fund Rate
• The Fed can increase the discount rate
• The Fed can sell bonds (Open Market Operations)
• The Fed can (theoretically) raise the reserve requirement, but probably won't because it is too complex for banks
• These Fed policies will decrease the interest rates through changes in the Money Supply
• These options should decrease Ig

Unit 4 - Money (3-21-16)

Key Concepts

#1 Reserve Requirement - Only a small % of your bank deposit is in the safe. The rest of your money has been loaned out. 

- Called "Fractional Reserve Banking" -

FED sets amount banks must hold -RR is the % of deposits that banks must hold in reserve and NOT loan out -FED increases the MS it Increases the amount of money held in bank deposits

1)Recession - what should FED do to RR? -Decrease the RRatio banks hold less money more ER banks create more money loaning out excess MS increases, interest rate fall, AD increases

2)Inflation - Banks hold more money less ER banks create less money MS decreases, interest rate increases, AD decreases

#2 Discount Rate - is the interest rate that the FED charges commercial banks

-To increase the MS, the FED should decrease the discount Rate (Ex:Monetary Policy)

-To decrease the MS, the FED should increase the Discount Rate (Ex:Tight Money Policy)

#3 Open Market Operations (OMO)

-FED buys/sells gov't bonds (securities)

-This is money important and widely used monetary policy

-Increase the MS FED should BUY gov't securities

-Decrease the MS FED should SELL gov't securities

Unit 4 - Money (3-11-16)

Unit - 4 Banking System

from the worksheet "Here are the Components and Definitions" and notes

Note- Money supply is affected by the money market graph and AD/AS graph.

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 (cont.)

• 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

• Reserve Requirement - Fed needs banks to always have $ to meet demand
• Amount = Reserve Ratio - % of DD locked to bank

Scenario 1

A private citizen takes cash that they possess and put it into a bank account

• The cash placed into the bank is already part of the money supply
• The deposit is counted as a bank liability
• A % must be placed into required reserve
• The remainder is placed into excess reserve
• The bank will want to lend all of the ER, if possible
• The amount in ER is multiplied by the monetary multiplier
• This will be assumed to become new loans in the banking system
• This will be counted as the change in money supply

Scenario 2

• The Fed buys bonds back from the public
• The public now has new cash
• This new cash is new loans
• Assume that the public puts the cash into demand deposits
• A set percentage is placed into required reserve
• The remainder becomes excess reserve
• Excess reserve is multiplied by the money multiplier (1/RR)
• This amount becomes new loans and is new money supply
• The total change in money supply is the amount of demand deposits plus the new loan amounts

Scenario 3

• The Fed buys bonds back from the member banks
• The banks now have new ER
• No money is needed to be placed in RR, since this is not owed to the public
• All of these ER are multiplied by the monetary multiplier
• This amount becomes new loans
• This amount is the change in the money supply

Unit 4 - Money (3-10-16)

Unit 4-Federal Reserve Bank (FED)

Wording is Key

Functions of the FED: presidential appointment

1. Issues paper money
2. Sets Reserve Requirements and holds reserves of the bank
3. Lends money to the banks and charges them interest
4. Check clearing service for banks
5. Acts as personal bank for the gov't
6. Supervises member banks
7. Controls the Money Supply

Unit 4 Money (3-9-16)

Unit 4 Time Value of Money

• Is a dollar today worth more than a dollar tomorrow? - Yes

• Why? - Opportunity costs & inflation -Reason for charging and paying interest 

Let 

v = future value of $ 

p = Present value of $

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

n = years

k = # of times interest is credited per year

Formulas

• Simple Interest Formula - -v = (1 + r)^n x p 
• Compound Interest Formula - - v = (1 + r / k)^nk x p

Money demand has an inverse relationship between nominal interest rates and the quantit of money demanded

1. What happens to the quantity demanded of money when interest rates increases?- Quantity demanded falls because individuals would prefer to have interest earning assets instead of borrowed liabilities. 
2. What happens to quantity demanded when interest rates decrease? - Quantity demanded increases, there is no incentive to convert cash into interest earning assets

What happens if price level increases?

• Money demand Shifters that affects investment 1. Changes in Price Level 2. Changes in Income 3. Changes in Taxation

Increasing the Money Supply

- If the FED increases the money supply a temporary surplus of money will occur at 5% interest. The Surplus will cause the interest rate to fall to 2%

How does this affect AD

Money supply (increase) -> interest rate(decrease) -> Investment (increases) -> Increases AD

Decreasing the Money Supply

Money supply (decreases) -> interest rate (increase) -> investment (decrease) -> Decrease AD

Financial Sector

Financial Assets (Own) vs Financial Liabilities (Owe)

Financial Assets -

-Stocks or bonds that provide expected future benefits

-Benefits the owner only if the issuer of the asset met certain obligations

Financial Liabilities

-Incurred by the issuer of a financial asset to stand behind/by the issued asset

Interest Rate - price paid for use of a financial asset

Stocks vs Bonds

Stocks

- Financial assets that convey ownership in a corporation

Bonds

-Promise to pay a certain amount of money plus interest in the future

What Banks do

• A bank is a financial intermediary - uses liquid assets (i.e. bank deposits) to finance the investment of borrowers
• Process kown as Fractional Reserve Banking - system which depository institutions hold liquid assets less than the amount of deposits

- Can take the form of: 1. Currency in bank vaults. 2. Bank Reserves - deposits held at the Federal Reserve

Basic accounting review

-T- Account (Balance sheet) - statement of assets and liabilities

Ex image:

- Assets (Amounts owned) - items to which a bank holds legal claim - the uses of funds by financial intermediaries

-Liabilities ( Amounts owed) - the legal claims against a bank - the sources if funds for financial intermediaries