Econ 252 Purdue exam 2

Potential Workers

Civilian non institutional population- everyone except children under 16, active military, institutionalized persons

Employed

Have a paid full time or part time job

Unemployed

No job, but are available for work and have looked for a job in the past 4 weeks

Labor Force

Unemployed +employed

Not in labor force

Persons without paid job and not actively searching for one

Labor Force Participation Rate (LFPR)

100%*(LF/PW)

Employment Population Ratio (EPR)

100%*(employed/PW)

Employment Rate (ER)

100%*(Employed/LF)

Unemployment Rate (UR)

100%*(unemployment/LF)

counterfactual

calculating unemployment rate with the same labor force as a year before

labor market

where the equilibrium real wage and quantity of labor are determined

demand for labor

determined by firms that want to maximize profits

supply of labor

determined by workers who want to maximize utility

Labor Demand

firms seek to maximize profits

Price Taking firms

perfectly competitive firm cannot influence prices of outputs or inputs

Marginal Benefit

value of the output produced by the last unit of labor

Marginal product of labor

increase in revenue resulting from hiring an additional worker

marginal cost

the cost to the firm of an additional unit of labor (market wage, w)

VMPl =

w = P*MPl = change in total revenue/change in Labor

Labor Demand Curve

depicts the relationship between the quantity of labor demanded and the wage, it is the VMPl

Labor demand curve shifts when there is a change in:

1. output price of the good or service

2. demand for the good or service

3. Tech progress and high productivity

4. Input prices of capital and land

culture hypothesis

societal values are responsible for differences in prosperity

return-to-entrepreneurship curve

shows the number of entrepreneurs with at least a particular level of returns

Frictional Unemployment

job seekers who have coordination problems being matched to the job openings, workers must undertake time consuming job search, arises because workers and firms have imperfect information about each other

Structural unemployement

wage is stuck above the market-clearing rate, there is wage rigidity, results from a persistent gap between the quantity of labor supplied and the quantity of labor demanded

Wage rigidity

caused by minimum wage laws, labor unions, and firms paying higher wages to increase worker productivity

Downward Wage Rigidity

most firms would rather fire some workers than cut wages

Cyclical Unemployment

relates to cyclical trends in growth and production in business cycle

Natural Rate of Unemployment

Difference between the current unemployment rate and its long term average, result of businesses not having enough demand for labor to employ all those who are looking for work

Debtors or borrowers

Economic agents such as entrepreneurs, businesses, home buyers, college students, who borrow funds

Credit

The amount of loans the debtor receives

Interest Rate

The additional payment, above and beyond the principal (loan amount) that a borrower makes on a $1 loan

Nominal Interest Rate

The annual cost of $1 loan, total interest payments = i x $L

Real Interest Rate

the annual real or inflation adjusted cost of a $1 loan, accounts for the decline in the value of one dollar because of the increase in the overall price level, given by r = i - pi (real interest rate= nominal interest rate - rate of inflation)

Quantity of credit demanded

The amount of loans that borrowers are willing to borrow at a given real interest rate

Credit demand schedule

a table that reports the quantity of credit demanded at different real interest rates holding all else equal

Credit demand curve

A curve that plots the quantity of credit demanded at different real interest rates

Why does the credit demand curve slope downward?

An increase in the real interest rate will raise the cost of borrowing. As a result, profits will be lower which in turn will decrease the number of potential borrowers

Credit demand curve shifts with changes in any of the following:

1. Perceived business oportunities for firms

2. Household preferences or expectations

3. Government Policy

Quantity of credit supplied

the amount of funds that people and firms save at a given real interest rate

Credit Supply Schedule

A table that reports the quantity of credit supplied at different real interest rates, holding all else equal

Credit supply curve

A curve that plots the quantity of credit supplied at different real interest rates

Credit supply curve shifts with changes in:

1. Changes in the saving motives of households because of expectations about the future or demographic changes

2. Changes in saving motives of firms: retained earnings

Balance sheet

records the assets and liabilities of a company, like a bank

Asset

is something owned by a bank, if asset is sold, the payment goes to bank

liability

something owed to another institution, if a liability is sold, the payment comes from the bank

Assets of a bank

Bank reserves (vault cash and holdings on deposit at Federal Reserve bank), Cash Equivalents (riskless, liquid assets that a bank can immediately access), and Long Term Investments (loans to households and firms and the value of the bank's properties)

Liabilities of a Bank

Demand deposits (funds that depositors can access on demand), Short Term borrowing (consists of loans from other financial institutions that are short in duration), Long term Debt ( debt that is due to be repaid in one year or more), Stockholders equity (difference between a banks total assets and total liabilities, equal to estimated value of company)

Total Assets=

Total Liabilities + Stockholders Equity

Banks perform 3 interrelated functions

1. Identify profitable lending opportunities

2. Transform short term liabilities into long term investments (maturity transformation)

3. Manage risk through diversification

Maturity

The time until a debt must be repaid

Banks manage risk by:

a) holding a diversified portfolio

b) transferring risk to stock holders and ultimately to the US government during a severe financial crisis

Money

an asset that people use to make and receive payments when buying and selling goods and services

medium of exchange

something that can be traded for goods and service, thereby facilitating trade

store of value

an asset that enables people to transfer purchasing power into the future

unit of account

universal yardstick that is used to express relative prices of goods and services

Fiat Money

an asset that is used as legal tender by government decree and is not backed by a physical commodity like gold

Money Supply

(M2) currency in circulation and checking accounts and savings accounts and travelers checks and most other types of bank accounts

Velocity

circulation rate of money, nomical GDP/ Money supply

Nominal GDP

total value of production using prices from the same year as the output was produced

Real GDP

total value of production using fixed prices taken from a particular base year

Growth rate of nominal GDP

growth rate of real GDP + GR of prices = GR of Real GDP and Inflation rate.

The Quantity Theory of Money

assumes that the ratio of money to GDP is constant

Inflation

situation of rising prices, equal to the gap between the growth rate of money supply and the growth rate of GDP

Deflation

situation of falling prices (negative inflation)

Hyperinflation

situation of extreme inflation where prices double within 3 years

Inflation rate=

GR of money supply-GR of real GDP

Relative Prices

real wage and real interest rate, can change, creates winners and losers

social benefits of inflation

1. generating gov revenue from printing currency

2. sometimes stimulating economy (fall in the real wage increases the firms willingness to employ, increases in the price of output shifts the labor demand to the right

social costs of inflation

1. inflation tax: decline in value of cash holdings due to inflation

2. Raising logisitcal costs: frequent price changes

3. Distorting relative prices

Deflation costs

1. high real interest rates that can't be offset by lowering the nominal interest rate

2. real burden of debt which is fixed in nominal terms rises when prices fall

What caused the German Hyperinflation of 1922-1923?

the German gov could not make reparation payments to the Allies after WWI, the gov started to print more and more currency to pay bills

Central Bank is gov institution that:

-monitors financial institutions

-controls certain key interest rates

-indirectly controls the money supply

-enforces monetary policy

Fed has 3 parts:

1. 12 fed reserves banks

2. 7 member board of Gov in DC

3. 12 member fed Open Market Committee

Fed two goals

1. low and predictable levels of inflations

2. maximum (sustainable) levels of employment

Fed does 3 things:

1. Influence short term interest rates (esp Fed Funds Rate)

2. influences the money supply and inflation rate

3. influences long-term real interest rates

Bank Reserves

provide liquidity, combo of deposits that private banks hold at central bank and cash in their vaults

Fed Funds Market

market where banks borrow and lend reserves to each other

Fed Funds Rate

overnight interest rate charged in this market

Demand curve for reserves shifts when:

1. economic expansion/contraction

2. Changing liquidity needs

3. Changing deposit base

4. Changing reserve requirement

5. Changing interest paid by Fed for deposits at Fed

Supply curve for reserves

vertical because Fed supplies not to earn economic profit but to pursue monetary policy

Open Market Purchase

Fed buys gov bonds from private banks and in return gives the private banks more reserves

Open Market Sale

Fed sells gov bonds to private banks and in return the private banks give some of their reserves

2 strategies to maintain policy

1. keep reserves fixed even when demand curve shifts and allow fed funds rate to fluctuate

2. supply more or less reserves to keep the fed funds rate constant (followed for 30 years)