Macro Exam 2

exam

productivity long definition

the main determinant of a nation’s standards of living, it is the quantity of goods and services produced from each unit of labor, a country’s standard of living depends on its (workers) ability to produce goods and services, high productivity leads to high real GDP leads to high income

productivity short definition

the amount of goods and services produced per hour of labor

productivity example

a worker who assembles 10 bikes in a day is more productive than one who assembles 5

human capital

the knowledge and skills a worker gains through education, training, and experience

human capital example

a doctor’s medical training

physical capital

tools, machines, and buildings used to produce goods and services

physical capital example

tractors used on a farm or computers in an office

technological knowledge

society’s understanding of how to produce goods and services

technological knowledge example

the invention of the internet or a new app that boosts efficiency

natural resources

inputs provided by nature like land, minerals, forests, and water

natural resources example

oil in Saudi Arabia, fertile soil for farming

ccatch up effect

the tendency for poorer countries to grow faster than richer ones by adopting existing technologies

catch up effect example

South Korea adopting Western manufacturing tech and growing rapidly

diminishing returns

when each additional input yields less and less output

diminishing returns example

adding more workers to a factory that’s already full-productivity per worker drops

foreign direct investment (FDI)

toyota building a plant in the US

foreign portfolio investment (FPI)

investment in a foreign country’s financial assets, like stocks or bonds

foreign portfolio investment (FPI)

buying shares of a Brazilian company from the US

productivity equation

Y/L x h

y=

total output (GDP)

L=

number of workers

h=

hours worked per worker

if GDP is 1,000,000 with 100 workers working 2,000 hours/year

productivity= 1,000,000/(100 × 2,000) = 1,000,000/200,000 = 5

GDP Per Capita (per person) equation

Real GDP/Total Population

If GDP= $500 billion, population= 50 million

500,000,000,000/50,000,000= $10,000

Financial System

institutions (banks, stock markets, bond markets) that match one person’s savings with another’s investment

national saving (S)

the total income in the economy that remains after consumption and government spending

national saving equation

S=Y-C-G

private saving

the income households have left after taxes and consumption

private saving equation

private saving= Y-T-C

public saving

the tax revenue the government has left after spending

public saving equation

public saving= T-G

budget surplus

when the government revenue (T) exceeds government spending (G) (public saving is positive)

budget deficit

when government spending exceeds revenue (public saving is negative, dissaving)

market for loanable funds

the market where those who want to save supply funds and those who want to borrow (invest) demand them

crowding out effect

when government borrowing increases interest rates, reducing private investment

GDP Identity equation

Y= C+I+G

national saving written out equation

private saving+ public saving

national savings equals investment in a closed economy

S=I

saving

income not spent

saving example

when households put money into the bank or bonds

investment

spending on new capital such as factories, machines, and buildings

A household puts $1,000 into a savings account

private saving

a firm builds a new factory

investment

the government runs a surplus

public saving

you buy stocks in a company

saving (not direct investment)

a company buys new equipment

investment

supply of loanable funds

comes from savers (households and sometimes foreign investors)

demand for loanable funds

comes from borrowers (firms for investment and government in deficit)

market role

suppliers- households (private savers), government (if surplus)

demanders- firms (investment), government (if borrowing to cover deficit)

real interest rate

adjusted for inflation, determined in the market for loanable funds

goods/product/output market

where actual goods and services are bought and sold, GDP and aggregate output are determined here

government budget deficit- crowding out effect event

government increases spending without raising taxes leads to budget deficit leads to public saving

government budget deficit- crowding out effect graph effect

supply of loanable funds shifts left, interest rate increases, and investment decreases

saving incentives (tax-free retirement accounts) event

government gives tax incentives for people to save more

saving incentives (tax-free retirement accounts) graph effect

supply of loanable funds shifts right, interest rate decreases, investment increases

money supply

the total amount of money available in the economy (currency+demand deposits)

monetary policy

The Federal Reserve’s actions to manage the money supply and interest rates to influence the economy

federal funds rate

the interest rate banks charge each other for overnight loans of reserves

liquidity

how easily an asset can be converted into cash

fractional reserve banking

a banking system where banks keep a fraction of deposits as reserves and lend out the rest

reserves

the portion of deposits that banks hold and do not lend out

reserve requirements

the minimum fraction of deposits banks must hold as reserves (set by the Fed)

reserve ratio

the percentage of total deposits held as reserves

reserve banking

the banking system where all deposits are held as reserves

fractional reserve banking

the banking system where banks hold only a fraction of deposits as reserves, where banks make loans or create additional money (or influence money supply)

How does the banking system create money? Under what system? What is the Fractional Reserve Banking system? – Create money under the Fractional Reserve system by:

accepting deposits, keeping a required reserve (set by the central bank), lending out the rest, the money that is lent out is spent and re-deposited into the banking system by others, where it can again be partially held and partially lent, this cycle multiplies the original deposit and expands the total money supply

four functions of the federal reserve (the fed)

1. conduct monetary policy-money supply: the fed manages the money supply and interest rates to influence inflation, employment, and economic growth

2. supervise and regulate banks: the fed ensures the stability and safety of the banking system by monitoring and regulating financial institutions

3. maintain financial system stability: acts as a lender of last resort to prevent bank failures and ensure trust in the financial system

4. provide banking services: acts as a bank for commercial banks and the U.S. government (processing checks, distributing currency, holding reserves)

Given:

Reserves = $1,500

Loans = $8,500

Deposits (liabilities) = $9,200

??? = Bank Capital

Assets

Liabilities + Capital

Reserves: $1,500

Deposits: $9,200

Loans: $8,500

Capital: ?

Assets = 1,500 + 8,500 = 10,000

Bank Capital = Assets - Liabilities

Bank Capital = 10,000 - 9,200 = 800

excess reserves equation

Total reserves- required reserves

reserve ratio equation

reserves/deposits

money multiplier

1/R

money supply

money multiplier x original deposits

bank capital

total assets- total liabilities

leverage ratio equation

total assets/bank capital

medium of exchange

money is used to buy goods and services

unit of account

money serves as a common measure to set prices and record debts, is the yardstick people use to post prices and record debts

store of value

money holds value over time, so people can save it and use it later

medium of exchange example

paying $5 for a sandwich

unit of account example

“$20” price tag on a shirt

store of value example

saving $100 in your wallet for next week

commodity money

has intrinsic value (can be used for something else)

commodity money example

gold, silver, cigarettes in prison

fiat money

has no intrinsic value, but is declared legal tender by the government

fiat money example

U.S Dollar, Euro

Open Market Operations (OMO)

buying/selling government bonds

discount rate

interest rate the fed charges banks for loans

reserve requirements

minimum % of deposits banks must hold as reserves

interest on reserves

interest the fed pays on reserves held by banks

What the Fed Does to Increase OMO Money Supply

buy bonds (injects money)

What the Fed Does to Decrease the OMO Money Supply

Sell bonds (removes money)

What the Fed Does to Increase the discount rate Money Supply

lower the rate

What the Fed Does to decrease the discount rate Money Supply

raise the rate

What the Fed Does to increase the reserve requirement Money Supply

lower the ratio

What the Fed Does to Decrease the reserve requirement Money Supply

raise the ratio

What the Fed Does to increase the interest on reserves Money Supply

lower interest

What the Fed Does to Decrease the interest on reserves Money Supply

raise interest

bank behavior

banks may choose to hold excess reserves and not lend

public behavior

people nay choose to hold cash instead of depositing it

loan demand

businesses or consumers might not want loans, even with low interest rates