209 terms

econ final

economic perspective
recognizes that all choices involve costs and that these costs must be involved in economic decision. to achieve a goal people must make decisions that reflect their purposeful self-interest, thirdly people compare marginal benefits against marginal costs and will choose the situation where the marginal benefit is greater than the cost.
specific view of economy, targets specific units in the economy, study research questions as how prices and inputs are determined for particular products and how consumers will react to price changes
focuses on whole economy, or large segments of it
positive economics
investigates facts and cause and effect relationships, and how the economy actually is
normative economics
subjective views of what ought to be or what polices should be used to address an economic issue. most disagreements between economists involve this form of economics
economizing problem
problem arises because individuals and society have unlimited economic wants, and economy and resources are limited.
opportunity cost
when a choice has to be made, the next best alternative that was not chosen
budget line
graphically the meaning of many concepts defined in chapter, sacricity, choice, trade offs,
production possibility curve
shows economic concepts and used to describe macroeconomic conditions related to unemployment, economic growth, and trage.
studies how individuals institutions and society make the optimal or best choices under conditions of scarcity, for which economic wants are unlimited and the means or resources are limited
economic perspective
has three interrelated features; opportunity cost, utility and marginal analysis
opportunity cost
giving up the next best alternative to the choice that was made
people seek to increase their satisifaction or utility, from consuming a good or service, they are purposeful because they weigh the costs and benefits in deciding how to best increase utility
marginal anaylsis
assess how the marginal costs of a decision compare with the marginal benefit
scientific method
develops a hypothesis which is a proposition that is tested and used to develop and economic theory
economic principle or law
a highly tested and reliable economic theory. theories, principles and laws are meaningful statements about economic behavior or the economy that can be used to predic the likely outcome of an action or event
economic model
created when several economic laws or principles are used to explain or describe reality
economic resources
scarce natural, human or manufactured inputs used to produce goods and services
factors of production
are also economic resources, classified into four categories land, labor, capital, entrepreneurial ability
four assumptions used with production possibility model
1. there is full employment of available resources 2. the quanity and quality of resources are fixed. 3. the state of technology does not change, 4. there are two types of goods and services being produced - consumer goods and capital goods
production possibility table
indicates the alternative combinations of goods an economy is capable of producing when it has acheived full employment and optimal allocation. the table illustrates the fundamental chocie every economy must make; what quantity of each product it must sacrifice to obtain more of another
production possibility curve
the data in the production possibility curce can be plotted on graph, each point on the curve represents some maximum output of the two goods
law of increasing opportunity cots
the opportunity cost of producing an additional unit of one good is the amount of the other good that is sacrificed. states that the opportunity cost of producing one more unit of a good ( the marginal opportunity cost) increases as more of the good is produced
production possibility curve bowed out from origin
beucase the law of increasing opportunity costs
opportunity cost of producing an additional unit of a good increases as more of it is produced
because resources are not completely adaptable to alternative uses
marginal cost curve for a good increases
because of the law of increasing opportunity costs, marginal benefit curve decreases becuase the consumption of goods yields less and less satisfaction
last word chapter one- sound reasoning about economic issues requires the avoidance of five pitfalls
bias- preconceived belief or opinion that is not warranted by facts. loaded terminology- use of terms in a way that appeals to emotion and leads to a nonobjective analysis of the issues. fallacy of composition- the assumption that what is true of the part is necessairly true of the whole. post hoc fallacy- after this, therefore because of this, is the mistaken belief that when one event precedes another, the first event is the cause of the second. confusing correlation- with causation means that two factors may be related, but that does not mean that one factor caused the other.
opportunity cost
always measured in terms of a forgone alternative, from a production possibilities table, you can easily calculate how many units of one product you forgo when you get another unit of product
independent variable ( income) on horizontal axis, dependent variable ( consumption) on vertical axis
economic system
two basic types- command system, market system
command system
extensive public ownership of resources and the use of central planning for most economic decision making in the economy. also called socialism or commmunism
market system
extensive private ownership of resources and the use of markets and prices to coordinate and direct economic activity. called capitalism
economic system
set of institutions and a coordination mechanism to respond to the economizing problem for an economy
market system has nine characteristics
private property, freedom of entreprise and freedom of choice, self interest, competition, markey, new technology, specialization or division of labor, money of exchange, government is active but limited role
the system of prices and markets and households and business firms choices furnish the market economy with answers to five fundamental questions
1. what goods and services will be produced? how will goods and services be produced? who will get the goods and services? how will the system acommodate change? how will the system promote progress?
consumer sovereignty
consumers are in command and express their wishes for the goods and services through dollar votes
creative destruction
creation of new technology creates market positive of firms adopting new technology and destroys market using old technology
invisible hand
compeitition in economy compels firms seeking to promote their own interests to promote the best interests of the society as a whole- efficient use of resources, incentive the system provides for productive activity, personal freedom
circular flow model or diagram
device used to clarify the relationships between households and businessses in market economy. resource market- households sell and firms buy resources. product market- firms sell and households buy products. - look at diagram
last word ch 2
there are twns of billions of ways that resources could be arragned in a market economy, but most combinations would be useless. the reason tha a market economy produces the few combinations from the total possible that are productive and serve human goals is becuase of private property. with it, people have an incentive to make the best use of their resources and find the most rewarding combination
any institution or mechanism that brings together buyers ( demanders) and sellers ( suppliers) of a particular good or service
schedule of prices and the quantities that buyers would purchase at each of these prices during a selected period of time
law of demand
states that there is an inverse or negative relationship between price and quantity demanded. other things equal, as price increases, buyers will purchase fewer quantities, and as price decreases they will purchase more quantities. there are three explainations for the law of demand: diminishing marginal utility, income effect, substitution effect
diminishing marginal utility
after a point, consumers get less satisfaction or benefit from consuming more and more unitys
income effect
a higher price for a good decreases the purchasing power of consumers incomes so they cant buy as much of the good
substitution effect
higher price for a good encourages consumers to search for cheaper substitutes and thus buy less of it
demand curve
has a downward slope and is a graphic representation of the law of demand
determinants of demand
price has most important influence but others are consumers tastes, the number of buyers in market, consumer income, price of goods, and consumer expectations- increase or decrease in entire demand schedule and demand curce ( change in demand) results from a change in one or more determinants of demand
normal goods
income and demand are positively related
inferior good
income and demand are negatively related
subsititute good
increase in the price of a related good will increase its demand . one good that will be used in place of another
complementary good
increase in the price of a related good will decrease its demand. one good that is used with another good
change in demand
means that the entire deamnd curve or schedule has changed because of a change in one of the above determinants of demand
change in quantity demanded
means that there has been a movement along an exisiting demand curve or schedule because of a change in price
a schedule of prices and the quantities that sellers will sell at each of these prices during some period of time
law of supply
shows a positive relationships between price and quantity supplied, other things equal, as the price of the good increases more quantities will be offered for sale, and that as the price of the good decreases, fewer quantities will be offered for sale
supply curve
graphic representation of supply and the law of supply; it has an upwardsloipe indicating the positive relationship between price and quantity supplied
determinants of supply
price has most important influence but other factors are resource prices, technology, taxes and subsidies, price of other good, price expectation, and number of sellers in market
change in supply
increase or decrease in the entire supply schedule and the supply curve, it is the result of a change in or more of the determinants of supply that affect the cost of production
change in supply
means that the entire supply curve or schedule has changed because of a change in one of the above determinants of supply
change in the quantity of supplied
means that there has been a movement along an existing supply curve or schedule becuase of the change in price
equilibrium price
or market-clearing price of a product is that price at which quantity demanded and quantity supplied are equal.
equilibrium quantity
is equal to the quantity demanded and supplied at the equilibrium price
excess supply, if the price of a product is above the market equilibrum price
excess demand, price of product is below the market equilibrium price
productive efficiency
in which the goods and services society desires are being produced in the least costly way
allocative efficiency
resources are devoted to the production of goods and services society most highly values
price ceiling
set by governement prevents price from performing its rationing function in a market system. it creates a shortage at the government set price
price floor
minimum price set by government for the sale of a product or resource. it creates surplus at the fixed price
last word ch 3
the supply and demand anaylsis can be used to understand the shortage of organ transplants. the demand curve for such organs is downsloping and the supply is fixed (vertical) and left of the zero price on the demand curve. transplanted organs have a zero price. at that price the quantity demanded is much greater than the quantity supplied creating a shortage that is rationed with a waiting list. a competitive market for organs would increase the price of organs and then make more available for transplant - make the supply curve up-sloping), but there are moral and cost objections to this change
business cycle
focuses on two topics; long run economic growth and short run changes in output and employment
long term growth trend leads to higher output and standards of living for an economy, but along the way there can be short-run variability that produces a decline in output
real gross domestic product, real GDP
is a measure of the value of final goods and services produced by the domestic economy during a time period, typically a year. the term real refers to the fact that in comparing the value of GDP ( price times quantity) from one year to the next, prices are held constant so only quantities of goods and services produced by the economy or real output changes.
modern economic growth
in which output per person and standards of living increased.
economic investment
refers to the purchase of newly created capital goods such as new tools, new machinery, or new buildings that are bought with the purpose of expanding a business
financial investment
refers to the purchase of an assest such as a stock, bond or real estate that is made for the purpose of financial gain
economic shocks
when expectations differ significantly from reality, unexpected happen
demand shocks
unexpected changes in the demand for products. most shorn run fluctations in economy come from demand shocks
supply shocks
occur with unexpected changes in supply of products
sticky prices
price of most products are inflexible or slow to change,causes issues with demand shocks - bc with demand shock if cant change price then change comes in output and employment
store of output that has been produced but not sold. when demand is low, inventory stock will rise.
national income accounting
consists of concepts that enable those who use them to measure the economy's output, to compare it with past outputs, to explain its size and the reasons for changes in its size and to formulate policies designed to increase it
gross domestic product GDP
the market value of all final goods and services produced in the domestic economy during the year is measured
is a monetary measure that is calculated in dollar terms rather than in terms of physical units of output, gdp includes in its calculation only the value of final goods ( consumption goods, capital goods, and services purchased by final users and that will not be resold or processed further during the current year, GDP excludes the value of intermediate goods to avoid multiple goods, another way to avoid multiple counting is to measure and add only the value added- market value of a firms output minue the value of the input the firm bought from other to produce the output
expenditures approach
required the summation of the total amounts of the four trypes of spending for final goods and services. includes; personal consumption expenditures C, gross private domestic investment Ig, government purchases G, net exports Xn. GDP = C+Ig+G+Xn
personal consumption expenditures F
are the expenditures of households for durable goods and nondurable goods and for services
gross private domestic investment Ig
is the sume of the spending by business firms for machinery, equipment, and tools; spending by firms and household for new construction buildings, and the changes in the inventories of business firms. * increase in inventory increases investment bc part of output that produced but not sold. decrease in inventories decrease investment bc included as part of output from a prior year
government purchases G
are the expenditures made by all levels of governments ( federal, state and local) for final goods from businesses and for the direct purchases of resources including labor
net exports Xn
in an economy is calculated as the difference between exports Xn and imports M. it is equal to the expenditure made by foreigners for goods and services produced in the economy minus the expenditures made by the consumers, governments and investors
income approach
adding the income derived from the production and sales of final goods and services. six income items are compensation of employees, rents, proprietors income, corporate profits, taxes on production and imports,
consumption of fixed capital
added to national income to get to GDP because it is cost of production that does not add to anyones income. it covers depreciation of private capital goods and publicly owned capital goods such as roads or bridges
net domestic product NDP
is the annual output of final goods and services over and above the privately and publicly owned capital goods worn out during the year. it equal to the GDP minus depreciation. depreciation ( consumption of fixed capital)
national income NI
the total income earned by US owners of land and capital and by the US suppliers of labor and entrepreneurial ability during the year plus taxes on production and imports. it equals NDP minus a statistical discrepanncy and plus net foreign factor income
personal income PI
is the total income received- where its earned or unearned by the housholds
disposable income
total income available to households after the payment of personal taxes. calculated by taking personal income- personal taxes.
nominal GDP
toatl output of final goods and services produced by an economy in 1 year multiplied by the market prices when they were produced, prices change each year. to compare total output overtime nominal GDP is converted to real GDP to account for these price changes
price index
used to derive real GDP from nominal GDP, price of a market in a given year/ price in base year multiplied by 100.
to get real GDP
divide nominal GDP by price index in hundreths
GDP shortcomings
excludes the value of nonmarket final goods and services that are not bough and sold in the markets, such as unpaid work done by people on their houses, excludes increased leisure enjoyed by ppl, doesnt account for the value of improvements in quality of products, doesnt measure the market value of the final goods and services, doesnt record pollution, doesnt measure noneconomic sources as reduction in crime, drugs etc
last word ch 7
the bureau of economic analysis BEA is a unit of the department of commerce that is responsible for compiling the national income and product accounts. it obtains date from multiple sources to estimate consumption, investment, government purchases, and net exports for the calculation of GDP
economic growth
defined in two ways- increase in real GDP over some time or as in increase in real GDP per capita- which takes size of population into account
rule of 70
approximate number of years required to double GDP can be calculated by rule of 70 which involes dividing 70 by the annual percentage rate of growth
modern economic growth
described by improvments in living standards that is continual and sustaned overtime
ingredients of growth
supply factor, demand factor, efficiency factor
supply factor
includes the quantity and quality of resources ( natural, human and capital) and technology
demand factor
influences the level of aggregate demand in the economy that is important for sustaining full employment of resources
efficiency factor
affects that efficient use of resources to obtain maximum production of goods and services ( production efficiency) and to allocate them their highest and best use by society (allocative efficiency)
labor productivity
real GDP=worker hours x labor productivity
labor force participation
the house of work are determined by the size of the working age population, labor force participation is the percentage of working age population in the labor force
labor productivity
real output per work house - is determined by many factors such as technological advance, the quantity of capital goods and the quality of labor, the efficiency in the use of inputs
growth accounting
two main factors are increases in quantity of labor ( hours of work) and increases in labor productivity
five factors to help increase labor productivity
technological advance, quantity of capital, human capital, economies of scale and improved allocation of resources
economies of scale
means that there are reductions in the per-unit-cost for firms as output expands. these economies occur as the market for products expands and firms have the opportunity to increase output to meet this greater demand
improved allocation of resources
occurs when workers are shifted from lower- productivity employment to higher- productivity employment in an economy, included in the category would be reductions in discrimminations in labor markets and reduced barriers to trade, both of which increase the efficient use of labor resources
productivity growth based on several factors
information technology, start up firms and increasing returns, network effects and learning by doing
last work ch 8
china has experienced annual rates of economic growth of almost 9% over the past 25 years. real income per capita has also increased by about 8 percent annually since 1980. the increased output and rising incomes fueled increases in savings and investment that in turn contribute to an increase in the stock of capital goods and technological advance. this economic growth is not without economic problems such as trade disputes, rising inflation , the unemployment of rural workers and government ineffieciencies
business cycles
peak, recession, trough -when output is no longer declining, this low point followed by expansion
unemployment rate
calculated by dividing the number of persons int labor force who are unemployed by the total number of persons in the labor force
unemployment rate criticized for two reasons
1. part time workers are considered fully employed, discouraged workers who have left the labor force are not counted as unemployment
frictional unemployment
due to workers with marketable skills searching for new jobs or waiting to take new jobs, this type of unemployment is short term, inevitable, and also generally desirable bc it allows people to find more optimal employment
structural unemployment
due to the changes in technology and in types of goods and services consumers wish to buy, these changes affect the total demand for labor in particular industries or regions. such unemployed wokrers have few desired markeyable skills so they often need retrainin, more eduction or have to move if they are to be employed
cyclical unemployment
arised from a decline in total spending in the economy that pushes an economy into an economic downtown or recession.
full employment unemployment rate or the natural rate of unemployment NRU
is the sume of frictional and structural unemployment and is achieved when cyclical unemploymen is zero ( the real output of the economy is equal to its potential output) NRU is the unemployment rate that is consistent with full employment. it is not however, automatically achieved and changes over time.
GDP gap
is a measure of that cost. it is the difference between actual and potential GDP, when the difference is negative it means that the economy is underperforming relative to potential
okuns law
predicts that for ever 1% the actual unemployment rate exceeds the natural rate of unemployment, there is a negative GDP gap of 2%
consumer price index CPI
primary measure of inflation in US
demand pull inflation
result of excess total spending in the economy or too much spending- increasing demand is pulling up the price
cost push inflation
result of factors that raise per-unit-production costs. this average cost is found by dividing the total cost of the resource inputs by the amount of output produced. as these costs rise profits are squeezed. major source of this inflation has been supply shocks from an increase in the price of resource inputs
real income
determined by dividing nominal income by the price level expressed in hundreths
unanticipated inflation
hurts fixed-income receivers, savers, and creditors because it lowers the real value of their assests
last work ch 9
do changes in the stock market affect the economy? the evidence indicates that changes in stock prices have only a weak effect on consumption and investment and the macroeconomy. stock market bubbles where there is a large increase in stock prices that then decline rapidly can adversely affect the macroeconomy. stock prices are relatively good indicator of future business conditions bc they are related to business profits
45 degree line
on the graph would show where consumption would equal disposable income, the difference is saving
consumption schedule
shows the amounts that households plan to spend for consumer goods at various levels of income, given a price level. break even income is where consumption is equal to disposable income
saving schedule
indicates the amounts households plan to save at different income levels, given a price level
average propensity to consume APC and average propensity to save APS
the precentages of income spent for consumption and saved, they sum to 1
marginal propensity for consume MPC and marginal propensity to save MPS
the percentages of additional income spent for consumption and saved sum to 1
are slopes of consumption and saving schedule
wealth effect
household income increases, they will spend more and save less bc of this increase in money
expected rate of return
directly related to the net profits that are expected to result from an investment. marginal benefit of investment for a business
real rate of interest
price paid for the use of money. it si the marginal cost of investment for a business. when the expected real rate of return is greaterthan the real rate of interest, a business will invest bc the investment is profitable
investment dmeand curve
shows this inverse relationship between the real rate of interest and the level of spending for capital goods. the amount of investment by the business sector is determined at the point where the marginal benefit of investment equals the marginal cost
six noninterest determinants of investment demand, and a change in any of these determinants will shift the investment demand curve
acquisition, maintenance, operating costs for capital goods change, business taxes, increase in technological progress,stock of exisiting capital goods, planned changes in inventories,expectations of future, capital goods are duarble, innovation is not regular, profit expectations, other expectations
ratio of the change in the real GDP to initial change in spending. the intitial change in spending typically comes from investment spending, but changes in consumption, net exports, or government spending. multiplier = 1/ (1-MPC) or 1/MPS. workbook pg 110
last word ch 10
art buchwald once wrote a humorous story about the multiplier that illustrates the spiral effect on consumer spending from a reduction in income. a car salesman reserved a car for a regular customer, but the customer cant buy the car bc he is getting divorced. which spirals a bunch of other people to lose work.
aggregate expenditures model
developed during great depression. with its constant price assumption is valuable for analysis of our modern economy because in many cases prices are sticky or stuck, model useful for understanding how economic shocks affect output and employment when prices are fixed or sticky- assumed the economy is private and closed- no international trate or government spending and also assumes that output or income measures are equal, real GDP= disposable income
equilibrium GDP is the
real GDP at which aggregate expenditures C+Ig=GDP, aggregate expenditures schedule crosses the 45-degree link, slope of this curve is equal to the marginal propensity to consume
equilibrium is acheived when planned investment equals savings
and there are no unplanned changes in inventories
equilibrium real GDP in an open economy
means real GDP is equal to consumption plus investment plus net exports
recessionary expenditure gap
equilibrium real GDP is less than the real GDP consistent with full employment realy GDP
inflationary expenditure gap
if aggregate expenditures are greater than those consistent with full employment real GDP, this expenditure gap results from excess spending and will increase the price level, creating demand pull inflation
last word ch 11
classical economist held the view that when there were deviations from full employment in the economy, it would eventually adjust and achieve equilibrium. this view was based on say's law which says that supply creates its demand. it implies that the production of goods will creat the income needed to purchase the produced goods. the events of the great depression led to doubts about this law and it was challenged by kenynes. Keynes showed that supply may not create its own demand bc not all income need be spent in the period it was earned, thus creating conditions for high levels of unemployment and economic decline
aggregate demand- aggregate supply model
explains why real domestic output and the price level fluctuate in the economy.
aggregate demand
curve that shows the total quantity of good and services (real output) that will be purchased (demanded) at different price levels. with aggregate demand there is an inverse relationship between the amount of real ouptut demanded and the price level so the curve slopes downward.
three reasons account for the inverse realtionship between real output and price level
real-balances effect, interest rate effect, foreign purchases effect
real balances effect
an increase in the price level decreases the purchasing power of financial assets with a fixed money value and because those who own such assests are now poorer, they spend less for goods and services, a decrease in the price level has opposite effects
interest rate effect
with the supply of money fixed, an increase in the price level increases the demand for money, increases interest rates, and as a result reduces those expenditures by consumer and business firms that are sensitive to increased interest rates, a decrease in the pirce level has opposite effects
foreign purchases effect
increase in the price level ( relative to foreign price level) will reduce US exports bc Us products are now more expensive for foreigners and epxand US imports bc foreign products are less expensive for Us consumers. as a consequence, net exports will decrease which means there wil a decrease in the quantity of good and services demanded in the US econony as the price level rises. a decrease in the price level will have opposite effect
determinants of aggregate demand
two components; the amount of in the initial change in one of the detereminants and the multiplier effect that multiplies the initial change, and the other determinants are consumer spending, investment spending, government spending, net export spending
aggregate supply
a curve that shows the total quantity of goods and services that will be producted at different price levels, shape depends on time horizon and how quickly input prices and output prices can change
immediate short run, aggregate supply
horizontal bc both input prices and output prices remain fixed, the horizontal shape implies that the total amount of output supplied in the economy depends directly on the amount of spending at the fixed price level
short run aggregate supply
aggregate supply curve is upsloping because input prices are fixed or highly inflexible and output prices are flexible and thus changes in he price level increase or decrease he real profits of firms
long run aggregate supply
aggregate supply curve is vertical at the full employment level of output for the economy because both input prices and output prices are flexible
determinants of aggregate supply
shift the curve include changes in he prices of inputs for production, changes in productivity, and changes in the legal and institutional environment in the economy
improves, per unit cost will fall and AS will increase. the outcome occurs because productivity (output divided by input) is in the denominator for the formula for per unit production costs
equilibrium real output and he equilibrium price level
are at the intersection of the aggregate demand and the intersection of the aggregate demand the aggregate supply curves. if price level were below equilibrium, then producers would supply less real output than was demanded by purchasers.
fiscal policy
consists of the changes made by the federal government in its budget expenditures and tax revenues to expand or contract the economy
expansionary fiscal policy
generally used to counteract the negative economic effects of a recession or cyclical downturn in the economy ( decline of real GDP and rising unemployment)
assuming price level is fixed, three options for increasing aggregate demand
1. govt can increase its discretionary spending, initial spending will be increased from multiplier effect, 2. govt to reduce taxes, 3. govt may decide to use some combination of increased govt spending and tax reductions
contractionary fiscal policy
restrictive form of fiscal policy generally used to correct an inflation gap. if aggregate demand increases ( shifts rightward) it will increase output and pull up output prices creating demand inflation. purpose of contractionary fiscal policy is to reduce aggregate demand pressure that increase the price level. if budget is balanced before policy enacted it will cause a budget surplus ( tax revenues are greater than govt spending)
the contractionary effect on the economy, three policies are used but account should be taken of the ratchet effect ( price level is inflexible downward)
1. govt can decrease spending, if price level is fixed bc of ratchet effect, the multiplier will have full effect in decreasing output, 2. govt can increase taxes, 3. govt can use combination
built in stabilizers
serve as nondiscretionary or passive fiscal policy. work through net tax revenues ( tax revenues minus government transfer payments and subsidies) these net tax revenues automatically or passively increase as the GDP rises and automatically or falls as GDP fails
GDP increases average tax rates will
increase in progressive tax system, remain constant in proportional tax and decrease in regressive tax system
standardized budget
better index than the actual budget of the direction of government fiscal policy bc it indicates what the federal budget deficit or surplus would be if the economy were operating in full employment
us securities
financial institutions issued by the US government to borrow money
false contentions about a large debt
1. that it will eventually bankrupt the government and 2 that borrowing to finance expenditures passes the cost on to future generations
in case of a budget deficit the standardized budget can
1. remove the cyclical deficit ( produced by downtown in economy), 2. reveals the size of standardized deficit
debt cannot bankrupt the govt
because the govt can refinance it by selling new bonds and using the proceeds to pay existing bondholders. it also had the constitutional authority to levy taxes to pay the debt
debt cannot be shifted to future generations
because US citizens and institutions hold most of the most of the debt. repayment of any portion of the principal and the payment of interest on it do not reduce the wealth or purchasing power in the US bc it would be paid to the US citizens and institutions. the only exception is the payment of the part of debt that would go to foreign owners of debt
problems with public debt
payment of interest further increases income inequality bc repayment goes to wealthier citizens, payment of taxes to finance interest payments may reduce incentives to bear risks causes economy to slow, external public debt repayment would transfer foreigners a part of the real output of the US economy, increase in govt spending crowds out private investment and reduces future stock of capital goods,
last word ch 13
the index of leading economic indicators consists of 10 economic variables; average length of the work week, initial claims for unemployment insurance, new orders for consumer goods, on time performance of vendors, new orders for capital goods, building permits for houses, stock prices, the money supply, spread in interest rates, consumer expectations, index is used to provide clues or indications about future direction of economy
ease with which such assets ( real estate, stocks, bonds) can be converted to money without losing purchasing power
stock of items rather than a flow such as income
money supply, 1. currency- consists of coins that are token money ( value of the metal in the coin is less than the face value), consists of paper money in form of federal reserve notes. 2. checkable deposits
two major types of financial institutions offering checkable deposits
commercial banks and thrift institutions
broader definition of money and includes not only the currency and checkable deposits of m1 but also near monies- which do not function directly or fully as a medium of exchange but which can be easily converted to currency or checkable deposits
m2 includes
m1 ( currency and checkable deposits), savings deposits, which include money in savings accounts, and also money market deposit accounts MMDAs, interest bearing accounts with short term securities, plus small time deposits of less than $100,000 such as certificates of deposits CDS, money market mutual funds MMMFs held by individuals
money has value bc
its acceptable for the exchange of desirable goods and services, it is legal tender (legally acceptable for payment of debts, relatively scarce bc its value depends on supply and demand conditions
value of dollar
value of dollar V = 1/p (price level)
federal reserve system ( the fed)
monetary and financial sector of the economy significantly influenced by
12 federal reserve banks of the fed have three main functions
1. they serve as the nations central bank to implement the policies set by the board of governors, 2 quasi public banks that blend private ownership of each federal. 3 they are the bankers banks
federal open market committee FOMC
responsible for acting on the monetary policy set by the board of governors. performs seven functions; issuing currency, setting reserve requirements and holding reserves, lending money to banks and thrifts
financial services industry
consists of banks, thrifts, insurance companies, mutual fund companies, pension funds, and securities firms
fractional reserve banking system
banks can only keep a part or a fraction of their checkable deposits by cash reserves
balance sheets
single commercial bank is a statement of assets, liabilities, and net worth ( stock shares) of the bank at a specific time, and in the balance sheet, the banks assets equal its liabilities plus its net worth
three reserve concepts are vital to an understanding of the money creating potential of a commercial bank
a. required reserves-which a bank must maintain at its federal reserve bank ( vault cash), equal the reserve ratio multiplied by the checkable deposit liabilities. b. excess reserves are equal to actual reserves less the required reserves. c. reserve ratio is the ratio of required reserves to a banks own checkable deposit liabilities. the fed has the authority to establish and change the limits set by congress
single commercial bank
multibank system can create money as the following two transactions; 1 granting a loan, 2 buying government securities
last word ch 15
during 1930s more than 6,000 banks failed within three years, this resulted in a multiple contraction of the nations money supply that totaled about 25 percent. the decline in money supply contributed to great depression. in 1033 banks were shut for a week for a bank holiday and a deposit insurance program was established to give confidence to bank depositors and to reduce the potential for panics, bank runs and large withdrawals of deposits
goal of monetary policy
achieve and maintain price stability, full employment and economic growth
price paid for the use of money
federal funds rate
interest rate that banks change each other for overnight loans of excess reserves is a focus of monetary policy
taylor rule
rule of thumb for federal reserves which specifies conditions for raises and lowering the federal funds rate based on the current rate of inflation and relationship between potential and real GDP
last word ch 16
mortgage debt crisis that began in 2007 required the federal reserve to take major actions to increase bank reserves to contain the financial disarray and stabilize the economy. the crisis started from defaults on subprime mortgages that had been packaged as bonds and sold as investments to banks and other financial institutions as creditworthy debt. the defaults produced losses that reduced bank reserves. the federal reserve responded to the financial crisis by serving as the lender of last resort for banks and lowering the discount rate by introducing a term auction facility to auction off more reserves for banks, and by reducing the federal funds rate. such actions were designed to increase aggregate demand and help the economy encounter an economic slowdown and possible recession
there are four different views among economists on instability in macro economy
mainstream view, monetarism, real business cycle theory, coordination failures
mainstream view
holds that instability in the economy arise from price stickiness and from unexpected shocks to either aggregate demand or aggregate supply. sticky prices make it difficult for the economy to quickly and fully adjust to economic shocks from either unexpected changes in aggregate demand or supply
focuses on money supply. think markets are highly competitive and government intervention destabilizes the economy. equation of exchange is MV=PQ, m- money, v- velocity, p = price level and q- quantity of goods. GDP/M is constant so is velocity. GDP/M=V
real business cycle theory
sees macroeconomic instability as being caused by real factors influencing aggregate supply instead of monetary factors causing shifts in aggregate demand
coordination failures
these failures occur when people are not able to coordinate their action to achieve optimal equilibrium
new classical economics
based on monetarism and rational expectations theory, says the economy may deviate from full employment output but it eventually returns to this output level bc there are self corrective mechanisms
last word ch 19
taylor rule specifies what actions the fed should take in changing the federal funds rate given chagnes in real GDP and inflation. this monetary rule has three parts;