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Macroeconomics Test #3
Terms in this set (30)
The Barter System+Problems
Goods and services are traded directly. No money is exchanged.
-Before trade can occur, each trader has to have something the other wants.
-Some goods can't be split (ex. If 1 goat is worth 5 chickens, what if you only want 1 chicken?)
Something that performs the function of money (it is a medium of exchange) AND has valuable, alternative uses. (ex. Gold, silver etc...)
A medium of exchange that serves as money but has no other important uses. It derives all value from its status as money. (ex. Paper bills)
-Doesn't tie up any resources
-Can be managed based on the economy's needs, instead of by the amount of available resources to make the currency.
3 Functions of Money
1) A Medium of Exchange
-Can easily be used to buy goods+services w/o complications of barter system.
2) A Store of Value
-Allows you to store purchasing power for the future.
-Doesn't die or spoil.
3) A Unit of Account
-Measures the value of all goods+services. Acts as a measurement of value.
Financial system is comprised of all financial institutions (banks), lenders, and borrowers within the economy.
Goals of the Financial System
1) Reducing Transaction Costs/Transportation Costs
-Transaction costs are the expenses associated with putting together and executing a deal.
2) Reducing Risk
-Help people reduce their exposure risk.
-A way to hedge risks and share profits.
3) Providing Liquidity
-Liquidity=The ease with which an asset can be accessed and converted into cash.
M1 (High Liquidity)=Currency and checkable deposits (personal and corporate checking accounts).
-In general, this is the MONEY SUPPLY.
-Excludes currency held at the Fed or other commercial banks because this money is not in circulation.
M2 (Medium Liquidity)=M1 plus savings deposits (money market accounts), time deposits (CD's=Certificate of Deposit), and Mutual Funds below $100K.
M3 (Low Liquidity)=M2 plus time deposits over $100K.
Bond=A loan or IOU that represents debt that the government or corporation must repay to an investor.
The bond holder has NO ownership of the company.
Dividends=Portions of a corporations profits which are paid out to stockholders-->The higher the corporate profit, the higher the dividend.
Capital Gain=Earned when a stockholder sells stock for more than he or she paid for it.
Money spent on new capital stock (or to replace old capital)
Buying or building an asset from which you expect financial gain
The Time value of Money
The idea that a specific amount of money is more valuable to a person now than it is in the future (or the sooner it is received).
-Money has time-value because current dollars can be converted into greater future dollars through interest.
-The Time-Value of Money is more about interest than about inflation.
The value that returns/costs that will arrive in the future, have today.
Equation: X/(1+i)^t dollars in t years=X dollars today where "i" is the interest rate and "t" is the number of years.
Interest which accrues not just on the original value, but on the previously accrued interest as well.
Equation: X dollars in t years=(1+i)^t (X dollars today) where "i" is the interest rate and "t" is the number of years.
Demand for Money
Shows an inverse relationship between nominal interest rates and the quantity of money demanded.
-When interest rates increase, quantity demanded falls because individuals would prefer to have interest earning assets instead.
3 Shifters for the Demand for Money
1) Changes in PRICE LEVEL!!
-If Price Level increases, demand for money increases.
-If Price Level decreases, demand for money decreases.
2) Changes in Income or GDP
-If income or GDP increases, there will be more things to buy so demand will increase as well so we can buy all the available products.
3) Changes in Taxation that affects Investment or Consumer Spending
Two Parts of the Fed
1) Board of Governors (7 people in D.C.)
-Appointed by President, and approved by the Senate. Terms of 14 years.
2) 12 Regional Federal Banks
-Serve regions of the country, audit private-sector banks.
When the Fed adjusts the money supply to achieve the macroeconomic goals.
3 Shifters of Money Supply
1) The Reserve Requirement/Ratio
-The percentage of deposits that banks must hold in reserve (the percent they cannot loan out).
-If there is a recession, the Fed should decrease the Reserve Requirement-->Multiplier will increase-->Banks create more money by loaning out excess money.
2) The Discount Rate
-The interest rate that the Fed charges commercial banks to take out short-term loans such as overnight loans.
-If there is a recession, the Fed should decrease the Discount Rate-->Encourages banks loaning money.
3) Open Market Operations
-When the Fed buys or sells government securities (ex. Treasury bonds).
-If the Fed buys gov. securities--> Increasing money supply.
-If the Fed sells gov. securities--> Decreasing money supply.
The Money Multiplier
Money Multiplier=1/Reserve Requirement
Equation for determining change in money supply
Change in Money Supply=(Money Multiplier)(Original change in money supply)
The Federal Funds Rate
The interest rate that banks charge each other for short-term loans such as overnight loans.
The Loanable Funds Market
-Comprised of the supply and demand for loans.
-This market shows the effect on Real Interest Rates.
-Households/consumers supply the funds and businesses are the only demanders for funds.
Demand for Loanable Funds
There is an inverse relationship between real interest rate and the quantity of loans demanded.
Supply for Loanable Funds
There is a direct relationship between real interest rate and the quantity of loans supplied.
2 Demand Shifters for the Loanable Funds Market
1) Changes in perceived business opportunities (ex. Tech boom in the 1990s and the ensuing crash).
2) Changes in government borrowing (Budget Deficit and Budget Surplus).
3 Supply Shifters for the Loanable Funds Market
1) Changes in private savings behavior (ex. 2000-2006 home prices were going up and savings went down).
2) Changes in public savings.
3) Changes in capital inflows (ex. Foreign countries parking money in domestic banks because of savings opportunities) (ex. Many countries putting money in banks in Argentina in the 1990s because of their high interest rates).
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