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FSU ECO 3223 - Study Guide

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INTRODUCTION – BRIEF OVERVIEW OF AD/SRAS/LRAS MODEL: 1. Be familiar with the structure of this model; meaning of horizontal and vertical axes, and the significance of the long-run aggregate supply curve. AD consists of: Consumers, gov spending, investment, net exports) SRAS: relationship between REAL GDP and price level, what economy can generate in short term LRAS: what we are capable of producing long term due to our level of tech, resources, capital2. Make sure you know the factors that will shift AD, SRAS, and LRAS. The Price Level is not one of them! AD: change in wealth, component spending. fiscal policy, monetary policySRAS: Price Shock, Changes in expected inflation, Persistent output gapLRAS: Technology, Capital3. What is the difference between short-run equilibrium and long-run equilibrium? The long run is the period when the general price level, contractual wage rates, and expectations adjust fully to the state of the economy, in contrast to the short run when these variables may not fully adjust.5. How does the “Invisible Hand” (the economy’s self-correcting mechanism) work? What are the components of the self-correcting mechanism? The invisible hand that will restore balance of the economy naturally through supply and demand. The components: Change in price level Change in Interest Rates6. How does the economy self-correct following a shift in AD? A shift in SRAS? CHAPTER 1: Understand the following: 1. the role that financial markets play in the economy. They give saved up excess funds from people who don’t presently need them, to those that do.2. the structure of a balance sheet (assets/liabilities/net worth), and the problem of “debt deflation”.Inflation only affects your assets, so if they become worth more than they should be, a bubble will form and your assets will crash back down to regular prices. However your liabilities wont change because that is a contractual agreement. Therefore you will now be in debt because you borrowed so much money thinking that you could keep reinvesting it in assets that were consistently raising in price.AssetsLiabilitiescashcredit cardsstockcar loansbondsmortgagehouse300,000 but drops to 100,000 due to deflationThen you have 100,000 dollars of debt200,0003. the interpretation of the movement of interest rates depicted in Figure 1. Important to note that there is more than one type of interest rate. Most important is Fed funds because all others are based on this rate. (which the federal reserve imposes) Also note that interest rates other than the Fed Funds are based upon varying levels of risk. Therefore a company that is more likely to pay your loan back will have to pay you less interest. (because YOU would rather loan someone your money who will pay you back than someone less likely 2) 4. from Figure 2, the reason for the sharp rise in the DJIA between 1990-2000; the steep declines in 2001 and 2007. Dot.com bubble, basically internet companies became way over valued and their prices crashed.5. the relationship between money supply growth and business cycles (Figure 3). Money supply will grow during business expansion because Companies will have more motivation to borrow money to invest it in possible ventures. 6. the reason for the “crossover” of M2 and the GDP Deflator depicted in Figure 4. GDP deflator and Money supply have always been directly related.However the cross over is due to the technological revolution which lowered the cost of production tremendously7. how to calculate a growth rate; real versus nominal GDP growth. Real GDP= Nominal GDP(of one year ie 2009 ) multiplied by the Deflator of another year (2008)all of this divided byThe deflator of the Nominal GDP in (2009)CHAPTER 2: Know the following:1. how financial markets benefit consumers; how they promote economic growth. They promote economic growth by moving funds from people who have saved to the people who need them to get stuff doneBenefit consumers by keeping money safe and providing a means to increase their wealth through investment2. the structure of the financial system (direct versus indirect; debt versus equity markets; primary versus secondary markets; money markets versus capital markets; brokers versus dealers).3. the main disadvantage of owning stocks versus bonds. If a company goes bankrupt, they must pay back the bond holders before stock holders, so stock holders might not be payed back4. the flow of funds through the financial system; major lenders/major borrowers (top two).5. two reasons that the secondary market is important to the primary market for stock; in which new financial capital is provided to the borrower.Fundamentally, secondary markets mesh the investor's preference for liquidity (i.e., the investor's desire not to tie up his or her money for a long period of time, in case the investor needs it to deal with unforeseen circumstances) with the capital user's preference to be able to use the capital for an extended period of time.6. the largest components of the money and capital markets, respectively.Components of the Capital market: 1. Bond Market - the market for debt instrument of any kind. 2. Mortgage Market - deals with loan or residential, commercial, and industrial real estate and on farmland. 3. Stock Market - common and preferred stocks issued by corporations are tradedMoney Marketi. The market for extremely short period loans.ii. Money at call and short noticeiii. The rate in this market is the "call money rate."iv. The rate is deter-mined by the de-mand and supply of funds.v. Money is lent mainly to the bill brokers and stock exchange dealers.7. the three major functions/benefits of financial intermediaries.Through the process of financial intermediation, certain assets or liabilities are transformed into different assets or liabilities. As such, financial intermediaries channel funds from people who have extra money or surplus savings to those who do not have enough money to carry out a desired activity.8. how financial intermediaries (a) lower transaction costs and (b) deal with asymmetric information between borrowers and lenders (both adverse selection and moral hazard issues).Adverse selection means anyone who wants to borrow is a risky individual based on the fact that they need to borrow money. Therefore everyone is carefully evaluated as a borrower.Moral Hazard: deals with behavior after the loan, A banker can write something into the contract


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