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ECON 2105: Final Test
factors of production
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land: all raw materials
labor: skilled to risk takers to special education
capital: machines, factories, etc.
entrepreneurship: "know how"
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marginal cost
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cost of consuming or producing one more unit
as you produce more, MC increases because of opportunity costs
not all resources are equally well suited
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marginal benefit
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benefit from producing or consuming one more unit
as you consume more, MB decreases
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comparative advantage
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if a person can perform the activity at a lower opportunity cost that anyone else
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allocative efficiency
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point that makes you "happiest" occurs at equilibrium
point where we cannot produce more of one good without giving up some other good that provides greater benefits
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specialization and trade
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increase amount of products
consume outside individual PPFs
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opportunity cost
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produce more of one good but have to give up some of the other good
as the quantity produced of each good increase, so does the opportunity cost
slope of PPF
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complements
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good that is used in conjunction with another good
ex. increase P peanut butter = Decrease Qd peanut butter = Decrease in D jelly
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substitutes
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good that can be used in place of another good
ex. increase P red bull = decrease Qd red bull = increase D mt. dew
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equilibrium
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place where you have no incentive to leave
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surplus
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supply too high / price too high
causes price to fall
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shortage
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demand too high and supply too low
causes price to increase
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law of demand
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the higher the price of a good the smaller the quantity demanded
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substitution effect
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better relative bargain
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income effect
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feel richer so buy more
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diminishing effect
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more you have the less you are willing to pay
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demand shifters
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Price of related goods
complements
substitutes
Expected future prices
Income
Population
Preferences
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substitute in production
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goods that a firm can produce by using the same resources
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expected future prices
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If the price of a good is expected to rise in the future, current demand for the good increases and the demand curve shifts rightward.
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income shifter
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normal good -- demand increases as income Increases
inferior good -- demand decreases as income increases
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law of supply
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the higher the price of a good, the more quantity supplied
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supply shifters
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Prices of factors of production
- increase in factor, decrease in supply
Prices of related goods produced
- substitutes in production
- complements in production
Expected future prices
Number of suppliers
Technology
State of nature
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GDP
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market value of all officially recognized final goods and services produced within a country in a given period of time
Y = C + I + G + X - M
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don't count in GDP
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1. intermediate goods
2. second hand goods
3. purely financial transactions
4. public transfer payments
5. unreported legal activity
6. illegal activity
7. non-market transactions
8. US firms producing overseas
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intermediate good
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purchased by firm to produce final good and sell to consumer
only counts when YOU buy it (final good)
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nominal GDP
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sticker value
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real GDP
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takes into account the value of a dollar
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potential GDP
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hypothetical
what you could produce at full employment
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unemployed
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1. doesn't have a job but has looked within the previous 4 weeks for one
2. waiting to be called back from a lay off
3. waiting to start a new job within 30 days
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labor force
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employed + unemployed workers
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unemployment rate
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UE = (# unemployed / labor force) x 100
4-6 is normal / healthy
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employment to population (could work)
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(employed / working age population) x 100
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labor force population rate (willingness to work)
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(labor / working age population) x 100
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types of UE
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1. frictional --> natural kind of employment
2. structural --> economy changes & kind of jobs change (longer than frictional)
3. cyclical --> fluctuates over business cycle
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inflation
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annual percentage change in price level
inflation rate = (CPI (this year) - CPI (last year)) / (CPI (last year)) x 100
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CPI |
consumer price index
measures the average prices paid by consumers for a "fixed" basket of consumer goods and sercives
CPI = (cost of CPI basket (current) / cost of CPI basket (base) - period) x 100
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CPI bias |
CPI might overstate true inflation
new good bias
outlet subset bias
quality change bias
commodity bias
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rule of 70
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number of years to double money = 70 / annual percentage growth rate
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Aggregate Production Function (AGF)
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relationship between real GDP and quantity of labor
direct relationship
curved because of law of diminishing returns
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grow economy
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increase labor
increase labor productivity (amt produced per person)
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labor productivity
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same number of people that can produce more
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capital gain
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increased market value of assets
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liquidity
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ability or ease with which assets can be converted into cash
borrows desire long term illiquid investments
depositors desire short term liquidity
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maturity transformation
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process of converting short-term liabilities into long-term assets
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insolvency
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inability to pay a debt
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real interest rate
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nominal interest rate adjusted for inflation
real = nominal - inflation
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loanable fund |
hypothetical market that brings savers and borrowers together, also bringing together the money available in commercial banks and lending institutions available for firms and households to finance expenditures, either investments or consumption.
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supply of loanable funds |
depends on: interest rate, disposable income, expected future income, wealth, default risk
Increase interest rate --> Increase profit from loan --> Increase supply of funds
upward sloping
savings is the main component
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Loanable fund supply movement vs. shift
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movement: change in interest rate
shift: change in savings (+income = ^s, +expected future income = -S, +wealth = -S) & change in default risk (^default risk, -S)
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Demand for loanable funds
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depends on: real interest rate, expected profit
increase interest rate --> increase cost of loan --> decrease profits --> decrease demand for funds
downward sloping
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loanable fund demand movement vs. shift
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movement: change in interest rate
shift: change in expected profit
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shadow banks
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investment banks
loan long-term funds
not heavily regulated
help other financial institutions and governments raise finance through issuing and selling stocks and bonds
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crowding out
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1. government deficit increases DLF
2. Real interest rate increases
3. increase household savings
4. decrease firm investments
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nominal interest rate
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actual percent interest payment on principal
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money functions
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means of payments
unit of account
medium of exchange
store of value
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M1
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most liquid
currency
checking deposits
traveler's checks
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bank reserves
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required reserve is 10%
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M2
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M1 + saving deposits and time deposits
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influences on money holding
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price level ( increase P --> carry more money)
interest rate ( increase interest rate --> carry less money)
real GDP ( increase GDP --> increase demand for money)
financial innovation (credit cards)
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monetary base vs. money supply
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monetary base
bank reserves + currency in circulation
bank reserves
money supply
checkable bank deposits + currency in circulation
larger than monetary base
does not include bank reserves
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MD
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movement: change in nominal interest rate
shifter: change in real GDP & financial innovation
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currency drain
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money exiting the system
currency drain ratio = currency / deposits
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fixed pegged exchange rate
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value decided by government that blocks the unregulated forces of demand and supply by direct intervention in the foreign exchange market
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flexible exchange rate / free float
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exchange rate is determined by demand and supply in the foreign exchange market
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interest rate parity
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short run
no-arbitrage condition representing an equilibrium state under which investors will be indifferent to interest rates available on bank deposits in two countries
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appreciation
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increase in currency's value
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depreciation
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decrease in currency's value
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PPP
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The equilibrium value of an exchange rate is at the level that allows a given amount of money to buy the same quantity of goods abroad as it will buy at home
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capital flow
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foremost short-run force on exchange rates
responsive to governmental policies and world economic conditions
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schools of thought
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classical: self regulating, always at full employment, free trade
keynesian: need fiscal/monetary policy (government intervention)
monetarist: self regulating, have to increase money supply
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business cycle
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The business cycle occurs because AD and SR AS fluctuate but the money wage rate does not adjust quickly enough to keep real GDP at potential GDP.
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recessionary gap
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real GDP < potential GDP
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inflationary output gap
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real GDP > potential GDP
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SR equilibrium
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QDreal GDP = Q Sreal GDP
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LRAS
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only one curve
price level does not change real GDP
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keynesian multiplier
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= total change in output / change in autonomous expenditure
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fiscal policy
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directly changes government purchases but indirectly influences AD
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automatic stabilization
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occur automatically in response to the state of the economy, without any action of the government
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discretionary stabilization
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fiscal policy initiated by an act of Congress and signed by president
either a change in spending program or change in tax la
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mandatory spending
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67%
already written into previous existing law
ex. Medicare, SS, paying off debt
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discretionary spending
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can be argued about
ex. defense and non defense
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deficit vs. debt
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deficit - difference between the money Government takes in and what the Government spends
debt - accumulated deficits
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monetary policy
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goals
maximize employment
moderate long term interest rates
stable prices (keep inflation rate low)
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money neutrality
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1. Fed increases money supply
2. interest rates decrease
3. AD shifts up
4. output and prices increase in SR (inflationary gap)
5. wages & other factor prices increase
6. SRAS shifts back
7. real output unchanged and price level increases
Changes in the quantity of money affect nominal variables such as the price level but not real variables such as output
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avoid recession
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decrease Federal Fund rate
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check rising inflation
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increase Federal Fund rate
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Fed tools
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1. open market operations
2. Overnight lending through the discount window
3. The new Term Auction Facility
4. Changing the federal funds rate target to respond to macroeconomic risk
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arguments for protectionism
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government restricts international trade to protect domestic producers from competition
1. infant government
2. infant industry
3. national defense
4. senile industry
5. job protection
6. retaliation
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