Unit 7: Absolute Advantage v. Comparative Advantage (4/29)

Absolute Advantage: faster, more, more efficient 

Individual: exists when a person can produce more of a certain good/service than someone else in the same amount of time. 

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

Comparative Advantage: lower opportunity cost 

Individual/National: exists when an individual or nation can produce a good/service of a lower opportunity cost than can another individual or nation. 

Input Problems:

The country or individual that uses the least amount of resources, land, or time has the absolute advantage. 

Output Problems:

The country that can produce the most has the absolute advantage. The country that has the lowest opportunity cost has the comparative advantage in that product. Deals with production. 

Unit 7: Foreign Exchange pt. 2 (4/27)

Purchasing Power Parity: When the currency rates are set by international markets, changes will be based on the actual purchasing power of the currencies. 

For example, if the U.S. dollar to the European Euro is $1.50 to 1, then each $1.50 will buy 1 Euro. However, if an item in the US costs $1.50 and then costs more or less than 1 Euro, the parity is lost. Markets will adjust quickly in floating rates or pressure for change will occur in fixed rates. 

Why do we exchange currencies?

1) To invest in other countries' stocks and bonds

2) To sell exports and buy imports

3) To build factories or stores in other markets

4) To hold currencies in bank accounts for future imports, exports, or business loans

5) To speculate on currency values 

6) To control excessive imbalances

Unit 7: Foreign Exchange Market (4/15)

Foreign Exchange: the buying and selling of currency. 

- Ex. In order to purchase souvenirs in France, it is first necessary for Americans to sell (supply) their dollars and buy (demand) Euros)

- The exchange rate (e) is determined in the foreign currency markets. 

- Simply put, the exchange rate is the price of a currency. 

- Do not try to calculate the exact exchange rate. 

Tips:

- Always change the D line on one currency graph, the S line on the other currency's graph. 

- Move the lines of the two currency graphs in the same direction (right or left) and you will have the correct answer. 

- If D on one graph increases, S on the other will also increase. 

- If D moves to the left, S will move to the left on the other graph. 

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 make it cheaper to buy one unit of that currency. 

- A decrease in supply of a currency will make it more expensive to buy one unit of that currency. 

- An increase in demand for a currency will make it more expensive to buy one unit of that currency. 

- A decrease in demand for a currency will make it cheaper to buy one unit of that currency

Appreciation of a currency occurs when the exchange rate of that currency increases (e goes up)

Depreciation of a currency occurs when the exchange rate of that currency decreases (e goes down)

- One hundred yen used to buy one dollar. Now 50 yen buys one dollar. 

- The dollar is weaker because it takes fewer Yen to buy one dollar. 

Exchange Rate Determinants

- Consumer Tastes

- Relative Income 

- Relative Price Level

- Speculation

Unit 7: Balance of Payments pt. 3 (4/14)

Balance of Trade = (goods and services of exports) - (goods and services of imports)

Trade Deficit: Imports > Exports

Trade Surplus: Exports > Imports

= Goods Exports + Good Imports

Current Account = Balance of Trade + Net Investment + Net Transfers

Capital Account = foreign purchases of U.S. assets + U.S. purchases of assets abroad

Official Reserves = Current Account + Capital Account 

Goods & Services = Goods Imports + Service Imports

Unit 7: Balance of Payments pt. 2 (4/10)

Balance of Payments - measure 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 payments is divided into 3  accounts

-current account

-capital/financial account

-official reserves account

Every transactions in the balance of payments is recorded twice in accordance with stand accounting practice

-Ex. US manufacturer, John Deere, exports $50 million worth of farm equipment to Ireland

A credit of $50 million to the current account (- $50 million worth of farm equipment or physical assets)

A debit of $50 million to the capital/financial account 

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 US owned foreign assets - income paid to foreign held US assets

- ex. Interest payments on us owned Brazilian bonds - interest payments on German owned US Treasury bonds

Net Transfers (tend to be unilateral)

-foreign aid to a debit to the current account

-ex. Mexican migrant workers send money to family in Mexico

Capital/Financial Account

-the balance of capital ownership

-includes the purchase of both real and financial assets

-direct investment in the US is a credit to the capital account

-ex. The Toyota Factory in San Antonio

-direct investment by US firms/individuals in a foreign country are debits to the capital account

-ex. The Intel Factory in San Jose, Costa Rico

Capital/Financial Account

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

-ex. Warren Buffet buys stock in Pentrochina

-purchase of domestic financial assets by foreigners represents a credit to the capital account

-ex. The United Arab Emirates 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.

IF THE CURRENT ACCOUNT HAS A NEGATIVE BALANCE (DEFICIT), THEN THE CAPITAL ACCOUNT SHOULD HAVE A POSITIVE BALANCE (SURPLUS)

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 buy sand sells dollars in order to maintain a steady exchange rate with the U.S.

Unit 7: Balance of Payments (4/9)

The Balance of Payments: measure 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 Payments is divided into 3 accounts:

1) Current Account

2) Capital Account

3) Official Reserves Account

Double Entry Bookkeeping

Every transaction in the balance of payments is recorded twice in accordance with standard accounting practice. 

Ex. U.S. Manufacturer, John Deere, exports $50 million worth of farm equipment to Ireland. 

- A credit of $50 million to the current account (-$50 million worth of farm equipment or physical assets)

Unit 5: Laffer Curve (4/7)

Supply-Side Economics: It is the belief that the AS curve will determine levels of inflation, unemployment, and economic growth. To increase the economy, the AS curve should shift to the right, which will always benefit the company first. Supply-side economists focus on marginal tax rates. Marginal tax rates is the amount paid on the last dollar earned or on each additional dollar earned. By reducing the marginal tax rate, supply-siders believe that you will encourage more people to work longer and forgo leisure time for extra income. They support policies that promote GDP growth by arguing that the high marginal tax rate along with the current system of transferred payments. They provide disincentives to work, invest, innovate, and undertake entrepreneurial ventures. It is also known as Reaganomics because Reagan lowered the marginal tax rate to get the U.S. out of a recession, which led to a deficit. 

Laffer Curve: It is a tradeoff between tax rates and government revenue. It is used to support the supply-side argument. 

3 Criticisms: 

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

2) Tax cuts increase demand, which can fuel inflation and causes demand to exceed supply. 

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

Unit 5: Long-Run Phillips Curve (4/6)

Long-Run Phillips Curve (LRPC)

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

- Increases in natural rate of unemployment will shift LRPC right

- Decreases in natural rate of unemployment will shift LRPC left

Stagflation: period with high inflation and high unemployment occurring at the same time. (VN War, Civil Rights Movement, Women's Movement, Oil Embargo)

Disinflation: reduction in the inflation rate from year to year. Nominal wages increase 

Deflation: situation in which there is an actual drop in the price level. Opposite of inflation.

Unit 5: Phillips Curve (4/2)

Phillips Curve: It represents the relationship between unemployment and inflation. The tradeoff between inflation and unemployment only occurs in the short run. 

Long-Run Phillips Curve: occurs at the natural rate of unemployment (4-5%). If the natural rate of unemployment changes, the LRPC changes. 

- represented by a vertical line

- there is no tradeoff between unemployment and inflation in the long run. The economy produces at a full employment level. 

- LRPC will only shift if the LRAS curve shifts. Otherwise, it is assumed to be stable. 

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

NRU = Seasonal + Frictional + Structural

Short-Run Phillips Curve

- There is an inverse relationship between inflation and unemployment. 

- It has a relevance to Okun's Law. 

- Since wages are sticky, inflation changes move the points on the SRPC. 

- If inflation persists and the expected rate of inflation rises, then the entire SRPC moves upward, which causes stagflation. 

- If inflation expectations drop due to new technology or economic growth, then the SRPC will move downward. 

- Aggregate supply shocks can cause both higher rates of inflation and higher rates of unemployment. 

- Supply shocks are rapid and significant increases in resource cost. 

- Misery Index: the combination of unemployment and inflation in any given year. Single digit misery is good. 

Unit 5: SRAS/LRAS (4/1)

I. SRAS: time too short for wages to adjust to the price level. The rational for SRAS is that workers may not be aware yet of changes in their real wages due to inflation and have adjusted their labor supply decisions and wage demands accordingly. 

- Nominal Wages is the amount of money received per day, per hour, or per year. 

- Real wages is adjusted for inflation 

- Sticky Wages: where the nominal wage level is set according to an initial price level and it does not vary. 

II. LRAS: time long enough for wages to adjust to the price level. In the long run, there is a flexible wage and price level. Both the wage and the price level offset each other. The same factors that move the PPG is the same that move the LRAS.  

Monetary Policy Viedo

Unit 4 - Money & Banking / Monetary Policy – 3-23 to 3-29

Video 1:

There are three types of money: commodity, representative, and fiat. Commodity money is money that is made of goods with another purpose. For example, cows, which have many uses other than money, were used as a type of money in Africa. Representative money is currency that is backed up by a precious metal, such as gold or silver, and is often unstable. Fiat money, the type of money we use today, is backed up by the word of the government. The three functions of money include being a medium of exchange, a store of value, and a unit of account. Being a medium of exchange allows money to be used in transactions. Being a store of value states that you can store your money, but it won’t be stable due to inflations. Being a unit of account allows price to imply worth, meaning that an item that is more expensive might mean that it is of higher quality, even though this may not always be true. 

Video 2:

In the money market graph, the y-axis is the interest rate the price you pay for money, and the x-axis is your quantity of money. The demand for money is downward sloping because when the interest rate is low, people have an incentive to borrow and invest more. The supply of money is vertical because it does not vary with the interest rate; it is fixed by the Fed. An increase in the demand of money creates upward pressure on the interest rate, but the quantity of money stays the same. If the Fed wants to stabilize the interest rate, the Fed can increase the supply of money, returning the interest rate back to what it was. If the interest rate is unstable, you cannot manipulate aggregate demand to give you the right economic change at the right time.

Video 3:

The Fed has three tools of monetary policy: changing the reserve requirement, changing the discount rate, and buying/selling bonds/securities. The RR is the percentage of the bank’s total deposits required to store as vault cash or on reserve at a Fed bank. The Fed does not change this often because it gives banks too much control on the money and it may be used irresponsibly. The discount rate is the interest rate that banks borrow from the Feds. This is not changed often because the Fed lowering the discount rate does not guarantee the banks will borrow the money. There is no guaranteed change in the money supply. Buying/selling bonds is the most used and effective way that the Fed changes the money supply. Buying/selling bonds puts upward or downward pressure on the Federal Funds Rate, the rate at which banks borrow money from each other.

Video 4:

Loanable funds is the money available for people to borrow. In this graph, the y-axis is the interest rate and the x-axis is the quantity of loanable funds. The demand for loanable funds is downward sloping because when interest rate is lower, the demand for loanable funds is higher. The supply of loanable funds is upward sloping and comes from the amount of money people have in banks; it is dependent on savings and how much banks have available. If the government is running a deficit, then the government is demanding money in order to spent it. This increases the demand for money on the money market graph, increasing the interest rate. The interest rate in the loanable funds market also increases, either due to a increase in the demand for loanable funds or a decrease in the supply of loanable funds. Either way, the increase in the interest rate for loanable funds should be the same as the increase in the interest rate for money.

Video 5:

In the money creation process, banks create money by making loans. The monetary multiplier equals 1/RR and the total money created equals the monetary multiplier multiplied by the loan amount. This makes up multiple deposit expansion. However, we must make the assumption that there are no excess reserves. If there are excess reserves, it will reduce the total amount of money created.

Video 6:

The loanable funds market, the money market, and the AD-AS graph are all connected. For example, when the government borrows money from Americans, the demand for money increases in the money market, increasing the interest rate. The demand for loanable funds also increases, also increasing the interest rate by the same amount. Lastly, aggregate demand increases, increasing the price level of goods. This results in the Fisher Effect, where an increase in the interest rate equals the same increase in inflation or price level.

Unit 4

Unit 4

3/3

Money is any asset that can be used to purchase goods and services

3 Uses of Money

1) Medium of Exchange - using money to determine value 

2) Unit of Account - used to compare prices

3) Store of Value - bank vs box

3 Types of Money

1) Commodity Money - it has value within itself (salt, olive oil, gold)

2) Representative Money - represents something of value (IOU)

3) Fiat Money - it is money because the government says so (paper currency and coins)

6 Characteristics of Money

1) Durability 

2) Portability

3) Divisibility

4) Uniformity

5) Limited Supply

6) Acceptability

Money Supply: the total value of financial assets available in the US economy

- M1 Money: 

   - Liquid Assets (easily to convert to cash) 

       - Coins

       - Currency (Paper)

       - Checkable deposits or demand deposits (checks)

       - Travelers Checks

- M2 Money: not as liquid as M1 Money

   - M1 Money + Savings Account + Money Market Account

3 Purposes of Financial Institutions

1) Store Money

2) Save Money

3) Loan Money

    1) Credit Cards

    2) Mortgages

4 Ways to Save

1) Savings Account

2) Checking Account

3) Money Market Account

4) Certificate of Deposit (CD)   

Loans

- Banks operate on a fractional reserve system; they keep a fraction of the funds and they loan out the rest. 

Interest Rates:

- Principal: the amount of money borrowed

- Interest: the price paid for the use of borrowed money 

   - Simple Interest: paid on the principal

   - Compound Interest: paid on the 

 principal plus accumulated interest

I = PRT/100

T= Ix100/PR

P = Ix100/RT

R = Ix100/PT

I = Simple Interest

P = Principal

R = Interest Rate

T = Time

Types of Financial Institutions 

1) Commercial Bank

2) Savings and Loans Institutions 

3) Mutual Savings Banks

4) Credit Unions

5) Finance Companies

Investment: redirecting resources you would consume now for the future 

Financial Assets: claims on property and income of borrower 

Financial Intemediaries: institutions that channel funds from savers to borrowers 

   1) Share risk through diversification - spreading out investments to reduce risk

   2) Provide information

   3) Liquidity (returns) - the money an investor receives above and beyond the sum of money that was initially invested

Bonds you loan

Stocks you own

Bonds: loans or IOUs that represent debt that the government or a corporation must repay to an investor. Generally low risk investments. 

3 Components of a Bond

- Coupon Rate: the interest rate that a bond issuer will pay to a bond holder

- Maturity: the time at which payment to a bond holder is due

- Par Value: the amount that an investor pays to purchase a bond (Principal)

Yield: the annual rate of return on a bond if the bond were held to maturity 

3/4

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 a decimal

n = years

k = number of times interest is credited per year 

The simple Interest Formula:

v = (1+r)^n x p

The Compound Interest Formula

v = (1 + r/k)^(nk) x p

The Monetary Equation of Exchange

MV = PQ

M = money supply (M1 or M2)

V = money's velocity (M1 or M2)

P = price level (PL on the AS/AD diagram)

Q = real GDP (sometimes labeled y on the AS/AD diagram)

7 Functions of the Fed

1) It issues paper currency

2) Sets reserve requirements and holds reserves of banks

3) It lends money to banks and charges them interest

4) They are a check clearing service for banks

5) It acts as personal bank for the government

6) Supervises member banks

7) Controls the money supply in the economy

3/5

The Three Types of Multiple Deposit Expansion Question

- Type 1: Calculate the initial change in excess reserves. aka, the amount a single bank can loan from the initial deposit. 

- Type 2: Calculate the change in loans in the banking system

- Type 3: Calculate the change in the money supply. 

- Sometimes type 2 and type 3 will have the same result (I.e. No Fed involvement)

- Type 4: Calculate the change in demand deposits. 

The amount of new deposits of new depots - required reserve = the i risk change in excess reserves. 

3/6

Reserve Ratio = (Commercial Bank's Required Reserves) / (Commercial Bank's Checkable-Deposit Liabilities)

Excess Reserves = Actual (Total) Reserves - Required Reserves

Required Reserves = Checkable Deposits x Reserve Ratio

Assets:
- Reserves
   - Required reserves: % reuquired by Fed to keep on hand to meet demand.
   - Excess Reserves: % reserves over and aboce the amount needed to satisfy the minimum reserve ratio set by the Fed.
- Loans to firms, consumers, and other banks (earns interest)
- Loans to government = treasury secutities
- Bank Property - if bank fails, you could liquidate the building.

Liabilities + Equity:
- Demand Deposits ($ put in the bank)
- Timed Deposits (CD's)
- Loans from: Federal Reserve and other banks
- Shareholders Equity  (to set up a bank, you must invest your own money in it to have a stake in the bank's success of failure

 3/17

Factors that weaken the effectiveness of the deposit multiplier

1) If banks fail to loan out all of their excess reserves 

2) If bank customers take their loans in cash rather than in new checking account deposits, it creates a cash or currency drain. 

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

MD or DM increases, interest rate decreases. 

MD or DM decreases, interest rate increases.

A single bank can create money through loans by the amount of excess reserves.
The banking system as a whole can create money by a multiple (deposition money multiplier) of the initial excess reserves.

Cash is existing money and increases bank reserves. there is no immediate change in MS, only composition of money changes.
When the Fed purchases a bond from the public, it is new money and increases bank reserves. There is an immediate change in MS coming from the Fed, it puts new money in circulation.
When the bank purchases a bond from the public, new money is made and bank reserves increase. There is an immediate change in MS because money is coming form the reserves, which puts new money in circulation.

3/19
The Fedearl Fund Rate is where FDIC member banks loan each other over night funds in order to balance accounts each day. Interest rate when banks borrow money from each other.
The Prime rate is the ineterst rate the banks chanrge to their most credit-worthy customers
The Discount Rate is the interest that the Fed charges commercial banks for borrowing money. Decrease during recession and increase during inflation.
The Reserve Requirement is the amoutn of money banks must keep in their reserves. Decrease during expansionary and increase during inflationary.
Open Market Operations, buying or selling securities/bonds - buy onds in expasionary, increase money supply. Sell bonds in contractionary, decrease money supply.

3/23

Loanable Funds Market: the market where savers and borrowers exchange funds (Qlf) at the real rate of interest (r%)

- The demand for likable funds, or borrowing comes from households, firms, government and the foreign sector. The demand for loanable funds is in fact the supply of bonds.

- The supply of loanable funds, or savings comes from households, firms, government and the foreign sector. The supply of loanable funds is also the demand for bonds.

Changes in the Demands for Loanable Funds:

- Remember that demand for loanable funds = borrowing (ie supplying bonds)

- More borrowing = more demand for loanable funds (shift right)

- Less borrowing = less demand for loanable funds (shift left)

- Example: Government deficit spending = more borrowing = more demand for loanable funds (Dlf shift right, r% increases)

- Example: Less investment demand = less borrowing = less demand for loanable funds (Dlf shifts left, r% decreases)

Changes in the Supply of Loanable Funds:

- Remember that supply of loanable funds = saving (ie demand for bonds)

- More saving = more supply of loanable funds (shifts right)

- Less saving = less supply of loanable funds (shifts left)

- Example: Government budget surplus = more saving = more supply of loanable funds (Slf shifts right, r% decreases)

- Example: Decrease in consumers' MPS = less saving = less supply of loanable funds (Slf shifts left, r% increases)

Final thoughts on Loanable Funds:

- When government does fiscal policy, it will affect the loanable funds market. 

- Changes in the real interest rate (r%) will affect Gross Private Investment.

-       M1 Money: currency (coins and paper money) in the hands of the public & all checkable deposits in commercial banks or savings institutions

o   Coins/paper money are debts of government and government agencies

o   Checkable deposits are debts of commercial banks and savings institutions.

o   Coins are token money, and has intrinsic value (metal worth less than coin)

o   Paper money is in the form of Federal Rserve Notes issues by the U.S. central bank (Federal Reserve System)

o   Checkable deposits largest component of M1 Money

-       M2 Money: M1 Money + Near-monies (may be converted into currency or checkable deposits

o   Savings account, money market deposit account, time deposits, money market mutual funds

-       With a constant demand for money, the supply of money will determine the value or purchasing power of the monetary unit.

-       Acceptability is more important than legal tender

-       Higher prices lower value of the dollar because more dollars are needed to buy something

o   If the price level doubles, the value of the dollar declines by one half

o   D = 1/P

-       Stabilization of money includes fiscal policy and monetary policy (regulation of money supply)

-       The main determinant of the amount of money demanded for transactions it the level of nominal GDP

-       When the interest rate or opportunity cost of holding money as an asset is low, the public will choose to hold a large amount of money as assets. When interest rate is high, people will hold less assets and buy more interest-bearing bonds.

-       Lower bond prices are associated with higher interest rates.

-       The collective attempt to buy more bonds due to a surplus in the money supply will increase the demand for bonds, push bond prices upward, and lower interest rates.

-       Higher bond prices are associated with lower interest rates.

-       When a commercial bank buys government bonds from the public, the effect is the same as lending. New money is created.

-       The selling of government bonds to the public by a commercial bank – like the repayment of loans – reduces the supply of money.

-       Reserves can be lost by individual banks, but there are no loss of reserves for the banking system as a whole.

-       Total Money Supply = Initial Checkable Deposits + Checkable Deposits Created Through Lending

-       When the Fed buys government bonds, the demand for them increases and their interest rates decline.