Unit 6

Economic Growth & Productivity

Economic Growth Defined

§  Sustained increase in Real GDP over time

§  Sustained increase in Real GDP per capita over time

Why grow?

§  Growth leads to greater prosperity for society

§  Lessens the burden of scarcity

§  Increases the general level of well-being

Conditions for Growth

§  Rule of Law

§  Sound Legal and Economic Institutions

§  Economic Freedom

§  Respect for Private Property

§  Political & Economic Stability

o   Low Inflationary Expectations

§  Willingness to sacrifice current consumption in order to grow

§  Saving

§  Trade

Physical Capital

§  Tools, Machinery, Factories, Infrastructure

§  Physical Capital is the product of Investment

§  Investment is sensitive to interest rates and expected rates of return

§  It takes capital to make capital

§  Capital must be maintained

Technology & Productivity

§  Research and development, innovation and invention yield increases in available technology.

§  More technology in the hands of workers increases productivity.

§  Productivity is output per worker.

§  More Productivity = Economic Growth

Human Capital

• People are a country’s most important resource. Therefore human capital must be developed.
• Education
• Economic Freedom
• The right to acquire private property
• Incentives
• Clean Water
• Stable Food Supply
• Access to technology

Hindrances to Growth

• Economic and Political Instability
• High inflationary expectations
• Absence of the rule of law
• Diminished Private Property Rights
• Negative Incentives
• The welfare state
• Lack of Savings
• Excess current consumption
• Failure to maintain existing capital
• Crowding Out of Investment
• Government deficits & debt increasing long term interest rates!
• Increased income inequality à Populist policies
• Restrictions on Free International Trade

Unit 5 Part 2

4/11/16

Ex. Assume that the US economy is in long-run equilibrium with an expected inflation rate of 6% and unemployment rate of 5% Then nominal interest rate is 8%

(a.) Using correctly labeled graph with both the short-run and long-run Phillip curves and the relevant numbers from above. Show current long-run equilibrium as Point A.

(b.) Calculate the real interest rate in the long-run equilibrium.

i%=n%-π%

    =8%-6%=2%

(c.) Assume now that the Federal Reserve decides to target an inflation rate of 3% What open-market operation should the Federal Reserve undertake?

Lower discount rate, buy bonds and decrease RR ratio

Inflation- general rise in the price level

Deflation- general decline in the price level

Disinflation- decrease in the rate of inflation over time

Stagflation- unemployment and inflation increasing at the same time

Supply-Side Economics AKA Reaganomics

-          Changes AS and not AD

-          Determines the level of inflation, unemployment rates & economic growths

Supply-Side Economists:

-          support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments such as unemployment compensation or welfare programs provide disincentives to work, save, innovate and undertake entrepreneurial ventures

Lower Marginal Tax Rates:

-          induce more work thus causing AS to increase

-          also make leisure more expensive and work more attractive

Incentive to Save & Invest:

1.      High Marginal Tax Rates: reduce the rewards for saving and investing

2.      Consumption might be increasing but investing depends on saving

3.      Lower marginal tax rates encourage saving and investing

Laffer Curve

-          There is a theoretical relationship between tax rates and government spending revenue

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

Criticisms

1.      Research suggests that the impact on tax rates on incentives to work, save and invest are small

2.      Tax cuts also increase demand, which fuels inflation and demand may exceed supply

3.      Where the economy is actually located on the curve is difficult to determine

Unit 5 Part 1

4/7/16

Extending the Analysis of Aggregate Supply

Short-Run Aggregate Supply:

·         Period in which wages (and other input prices) remain fixed as price level increases or decreases

*wages are constant; prices fluctuate*

Long-Run Aggregate Supply:

·         period of time in which wages have become fully responsible to changes in price level

*vertical line at full employment*

Effects over SR

·         price level changes allow for companies to exceed normal outputs and hire more workers because profits are increasing while wages remain constant

·         In long-run, wages will adjust to price level and precious output levels will adjust accordingly

Equilibrium in the Extended Model

·         The long AS curve is represented with a vertical line at full employment level of real GDP

Demand Pull Inflation in AS Model

►   Demand-Pull: prices increase based on 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 arises from factors that will increase per unit costs such as increase in the price of a key resource

Dilemma for the Government

►   In an effort to fight cost-push, the government can react in two different ways

►   Action such as spending by the government could begin as inflationary spiral

►   No action however could lead to recession by keeping production and employment levels declining

                                                                                                                                                               4/8/16

The Phillips Curve

Long-Run Phillips Curve

Note: Natural rate of unemployment is held constant

v  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

v  Increases in Un will shift LRPC à

v  Decrease in Un will shift LRPC ß

Short-Run Phillips Curve

►   There is a tradeoff between inflation and unemployment

Inflation ▲ Unemployment ▼

Inflation ▼ Unemployment ▲

Long Run Phillips Curve

►   There is NO tradeoff between inflation and unemployment

►   It is represented by a vertical line

►   It occurs at the natural rate of unemployment

►   LRPC will only shift if LRAS shifts

NRU= Frictional + Structural + Seasonal Unemployment

Standard Unemployment Rate à 4% to 5%

Major LRPC assumption: is that more worker benefits create higher rates and fewer worker benefits create lower rates

Supply Shocks: caused by rapid, and significant increases in resource cost, which causes the SRAS curve to shift

Misery Index: combination of unemployment and inflation in a given year; single digit misery is good

Unit 4 Notes Part 3

Types and Functions of Money


There are 3 different types of money: 

Commodity Money is a good that has other purposes that also functions as money - an example would be tribes in Africa using cows as money. 

Representative money is whatever you are using as currency represents a specific quantity of a precious metal (gold, silver) - the drawback is when the value of the metal changes, it affects the value of your national currency. 

Fiat Money is not backed by a precious metal - it is money that must be accepted for transactions and is backed by the word of the government that it has value.
Functions of money include the Medium of Exchange, the Store of Value (put money away in hopes to retain its value), and the Unit of Account (Price implies Worth (quality).


Money Market Graphs


When the price is high, the quantity demanded is low and when the price is low, the quantity demanded is high.

When the interest rate is low, people have an incentive to borrow more for transactions, to hold assets, transaction demand, asset demand.

The supply of money does not vary based on the interest rate - demand for money is tied to the interest rate, supply of money is not. The supply of money is fixed, it is set by the Fed - it doesn't move unless the Fed does something to move it.

The Fed's Tools of Monetary Policy

Reserve Requirement is the percentage of the bank's total deposits that they must hang on to, either as vault cash or on reserve w/ a Fed branch. Discount Rate is the rate at which banks can borrow money from the Fed.

For Expansionary Policies (easy $), the RR decreases; the DR decreases (for banks to borrow more money); and if the Fed wants to expand money supply, it buys bonds.

For Contractionary Policies (tight $), the RR increases; the DR increases (to discourage banks form borrowing money); and if the Fed wants to contract or reduce the money available, it sells bonds.

The Loanable Funds Mar

Loanable Funds is money that is available in the banking system for people to borrow.
When the interest rate is lower, people demand more money and when the interest rate is higher, people have a disincentive to borrow.

 Supply of Loanable Funds comes from the amount of money that people have in banks, it is dependent on savings. The more money people save, the more money banks have available to make loan.

 If people have an incentive to save more, then you increase the supply of loanable funds. If people have incentives to save less, you decrease the supply of loanable funds.

Money Creation & Multiple Deposit Expansion

Banks create money by making loans. One of the FED's tools for monetary policy is the ability to control the Reserve Requirement (RR).
Money Multiplier = 1/RR        RR = 20%      Loan amount = $500
What is the total money created? 1/0.2 = 5 × 500 = $2,500. We got $2,500 by using the process of Multiple Deposit Expansion.


Relating the money Mkt., Loanable Funds Mrk., and AD - AS


In the money market, the governemnt is borrowing money from Americans.
A change in the money market will carry through the loanable funds graph, and the aggregate demand and supply graph.
In this case of a government deficit, the increase in demand, results in an increase in the interest in the money market applies to the loanable funds graph. The aggregate demand is an increase, causing a rise in the price level and GDP.
 According to the equation of exchange, MV = PQ, a change in the supply of money causes a change in price, shown as an increase in interest rates will increase the price level.
All three graphs are related by the Fisher Effect, a 1:1 direct ratio.

Unit 4 Part 2

3/10/16


Ultimate Lenders --> Financial Intermediaries --> Ultimate Borrowers 


What Banks Do - Basic Accounting Review 
T-Account (Balance Sheet):
Statements of assets & liabilitiesAssets (Amounts owned):
Items to which a bank holds legal claimThe use of funds by financial intermediariesLiabilities (Amounts owned):
The legal claims against a bankThe sources of funds for financial intermediaries


Federal Reserve Bank (The Fed):

Houses the Secret Service7 board members appointed by President 

  Functions: 

Uses paper currencySets reserve requirements & holds reserves of the banksIt lends money to the banks & charges them interestThey are check-clearing service for the banks Acts as personal bank for the government Supervises members' banksIt controls the money suplly in the economy 



How do banks create  money? 

  - By lending out deposits  that are used       multiple times. 


Where do the loans come from?

- They come from depositers who take cash and place it in their banks.


How are the amounts of potential loans calculated? 

- By using the balance sheet or the T-Account that consists of liabilities and assets


Bank liabilities (on the right side of T-Account)

#1 Demand Deposits or Checkable Deposits 

    - They belong to depositers and can be withdrawn by depositers 

#2 Owner's Equity 

   - Values of stock held by the public ownership  of bank shares



Bank assets (the left side of the T-Account)

#1 Required Reseves

- Percentage of demand deposirs that must be held in the vault so that some depositers have access to their money

#2 Excess Reseves 

#3 Property 

#4 Securities (Bonds)

#5 Loans



Reserve Requirement:

The Fed requites banks to always have some money readily available to meet the consumer's demand for cash.The amount set by the Fed, is the Required Reserve Ratio.The Required Reserve Ratio is the % of demand deposits (checking account balances) that must not be loaned outTypically the Required Reserve Ratio = 10% 


The Three Types of Multiple deposit Expansion Question:

Type 1: Calculate the initial change in excess reserves the initial deposit

Type 2: Calculate the change in loans in banking system

Type 3: Calculate the change in the money supply. 


*Sometimes Type 2 & Type 3 will have the same result (i.e. NO Fed involvement)


3/21/16

#1. The Reserve Requirement:

Only a small percent of your bank deposit is in the safe. The rest of your $ has been loaned out. The reserve requirement (reserve ratio) is the % of deposits 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 bank deposits. 




If there is a RECESSION, what should the Fed do to the Reserve Requirement? 

- Decrease the Reserve Ratio

Banks hold less money & have more excess reservesBanks create more money by loaning out excessMoney supply increases, interest rates fall, AD goes up. 

If there is INFLATION, what should the Fed do to the Reserve Requirement?

- Increase the Reserve Ratio 

Banks hold more money & have less excess reservesBanks create less moneyMoney supply decease, interest rates up, AD goes down. 


#2. The 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 (Easy Money Policy)To DECREASE the Money Supply, the Fed should INCREASE the Discount Rate (Tight Money Policy)


#3. Open Market Operations:

The Fed buys/ sells government bonds (securities).This is the most important and widely used monetary policy.To INCREASE the Money Supply, the Fed should BUY government securities.To DECREASE the Money Supply, the Fed should SELL government securities.



Federal Funds Rate:
Where FDIC member banks loan each other overnight bonds. Prime Rate:
The interest rate that banks give to their most credit-worthy customers. 



If the economy  goes into recession, the real GDP will decrease for at least 6 months.

If the economy suffers from too much ddemand-pull inflation  or cost inflation 

Unit 4 Part 1

Unit 4

Money:
Uses of Money
Medium of Exchange- barter & trade
Unit of Account- establishes economic value
Store of Value- money holds its value over a period of time, whereas products may not
Types of Money
Commodity Money- it gets its value from the type of material from which it is made (Ex. gold & silver coins)
Representative Money- it is paper money backed up by something tangible that gives it value 
Fiat Money- is money because the government says so
Characteristics of Money
Divisible- can be split (dollars into coins)
Portable- taken anywhere
Uniform- a dollar is a dollar
Acceptable- accepted by all
Scarce- limited
Durable
Money Supply
M1 Money- (75%) it is the most liquid (easy to convert to cash)
Currency: cash & coins
Checkable Deposits/Demand Deposits
Traveler’s Checks
M2 Money- consists of M1 Money, savings accounts, and deposits held by banks outside the U.S.
M3 Money- consists of M2 Money & certificate of Deposits (better known as CDs- money kept in the bank, collecting interest for x amount of time)

3/9/16
Time Value of Money
Is a dollar today worth more than a dollar  tomorrow? 
Yes
Why?
Opportunity cost & inflation
This is the reason for charging and paying interest

Let: 
v= future value of $
p= present value of $
r= real interest rate (nominal rate- inflation rate) expressed as decimal
n= years
k= number of times interest is credited per year

The Simple Interest Formula:
                                                       v=(1+r)^n×p
The Compound Interest Formula:
                                                       v= (1+r/k)^nk×p

The Money Market

Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded
What happens to the quantity demanded of money when interest rates increase?
Quantity demanded falls because individuals would prefer to have interest earning assets instead of borrowed liabilities
What happens to the quantity demanded when interest rates decrease? 
Quantity demanded increases. There is no incentive to convert cash into interest earning assets.

The Demand of Money
What happens if price level increases?


Money Demand Shifters
Changes in price level 
Changes in income
Changes in taxation that affects investment
Increasing the Money Supply

Decreasing the Money Supply

Financial Liability- something you owe

Financial Asset- something you own

Interest Rate- the cost of borrowing money

Stocks

Bonds

Share of a company; stockholders

Lending money to the govt & they promise to pay it back with interest

What Banks Do

A bank is a financial intermediary

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

Process is known as Fractional Reserve Banking 

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

Can take the form of: 

Currency in the bank vaults

Bank Reserves- deposits held at the Federal Reserve

T-Account (Balance Sheet)

Statements of assets and liabilities

Assets (amount owned)

Items to which a bank holds legal claim

The uses of funds by financial intermediaries

Liabilities (amount owed)

Legal claims against a bank

Sources of funds for financial intermediaries

Unit 4 Monetary Policy Video

Monetary Policy Unit 4 Video