Economic Final

Keynesian essentials

1) Total expenditures may not equal full employment

2) Savers and investors have different motivations

3) prices and wages are not flexible

Aggregate Expenditures

C+I+G+(X-M)

Fundamental Psychological Law of consumption

consumption increases with income but not as much, autonomous or induced

Autonomous

unrelated to income ex government spending

Induced

occurs because people have income to spend

Marginal propensity to consume (MPC)

change in C/ change in disposable income

MPS Marginal propensity to save

change in S/change in disposable income

1=

MPC+MPS

Multiplier

the proportional increase in national income that results from an increase in demand or spending

Multiplier Equation

1/1-MPC

change in income=

Multiplier x change in investment

Discretionary Policies

you decide when to use them, 1)Gov spending 2) Tax rate change

Problems of Fiscal Policies

1) Predicting cycles + add policies

2) What will the multiplier effect be?

3) Crowding out businesses by gov borrowing

4) Political not economic

Tax increase of 1932

Hoover, made the economy worse. Classical

Tax cut of 1964-65

led to rapid economic growth after stagnate growth, a budget surplus. Keynesian consumption stimulus

Tax cuts of the 1980s

Reagan, led to large budget deficits. Supply-side, Laffer Curve

The Laffer curve

how tax rates relate to government tax revenue

Characteristics of Money

1) Medium of exchange

2) Means of measuring value (accounting)

3) Keeps its value

Commodity money

has value in its own right

Fiat money

“Because we command” money. Has no inherent value outside of a government’s official backing

Seigniorage

is the difference between the value of money and the cost to produce and distribute it.

M1

Currency + demand deposits (checking accounts) + travelers’ checks

M2

M1 + savings accounts + other small time deposits

Difference between M1 and M2

based on liquidity

Financial Intermediaries

1) Savings and Loan associations

2) Mutual savings bank

3) credit unions

4) commercial banks

Gresham’s Law

“Bad money drives out good” want to keep good money get rid of bad

Goldsmith’s principal

Not all customers of a bank will withdraw their funds at the same time

Dual Banking system

national and state banks

Required reserves

reserves a bank mush hold to back deposits

money multiplier (Demand deposit)

1/required reserve ratio

Roles of a central bank, deal with

1) commercial banks

2) government

3) money supply

4) money markets

Federal Reserve System

Federal open market committee → Board of Governors → Federal Reserve Banks

Tools of the Federal Reserve

1) reserve-requirement ratios

2) open-market operations

3) discounting operations

4) stock market margin requirements

Reserve-requirement ratios

can determine how much reserves must back deposits in private banks

open-market operations

the buying and selling of government bonds to change the money supply

discounting operations

set interest rate for borrowing from the Fed and among banks

Information Lag

you must measure macroeconomics variables. The accurate results aren’t known till months after the fact

Recognition Lag

Once you have the information you must determine what it means. Economic events are not always clear while you are in them

Decision Lag

It takes time to decide what to do

Implementation Lag

Policies take time to be implemented and to work

Transactional

you want to spend it

Precautionary

to uncover unanticipated spending

Asset Demand

holding money as wealth. This is a Keynesian view only. This demand depends on interest rate

For classical view

holding money is at the cost of goods and services

For Keynesian view

holding money is at the cost of interest and might be done

Equation of exchange

MV=PQ = GDP and M~P

What do M, V, P and Q stand for

M=money supply, V=income velocity, P=average price level, Q=output of economy

Classical Quantity Theory Money

Assumes V and Q are constant, so average price is proportional to quantity of money, Only works for Long run

Money Supply Rule

Friedman said V does change so M=kPQ, monetary policies aren’t useful, let money supply grow but no discretionary policies.

Real money demand

f(w, r, pe, u)

What do w, r, pe, and u stand for?

w=permanent income, r= return on assets, pe= expected inflation rate, u=individual taste

Keynesian Aggregate Supply

Use monetary policy to shift Q (output demand) when left of full employment

Phillips Curve

shows inverse relationship between inflation rate and unemployment rate. Keynesian view

Policy Target Long Run

price stability (low inflation)

Policy Target Short Run

price level and income (prevent recession)

Trade Factors

most trade involves wealthy nations (US, EU, UK, Japan, China), most value in manufactured/finished goods

Absolute Advantage

Adam Smith, the ability to produce more of a good or service than another entity using the same resources

Comparative Advantage

David Ricardo, prioritizes producing the good with a lower opportunity cost relative to another

Heckscher-Ohlin Theory of Factor Endowments

A country's advantage in global trade comes from having more of certain resources compared to other countries.

Why not free trade?

1) Protection of special interests

2) Security of supply

3) Unfair competition

4) Infant Industry

Protection of Special Interest

everyone gets some benefit from trade, but a few are hurt by losing their jobs which stands out, Stolper-Samuelson Theorem

Security of Supply risks

supply cut-offs: political unrest, political strategy, military action

Ways to handle security of supply risks

substitutes and alternatives, stockpiles, subsidize domestic industry

Unfair Competition

Dumping, a company selling products in a foreign market at a price lower than its domestic market price. Can be fought with government subsidies and regulations

Trade restriction methods

1) tariffs (taxes)

2) Quotas (quantity restrictions)

3) Administrative: health & safety, standards

Bretton Woods

A new international monetary system to replace the international gold standard, it set up an adjustable pegged rate system.

International Monetary Fund

to oversee the international monetary system and to provide short-tern balance-of-payment loans

World Bank

provides long-term development loans. Funding comes from commercial sources and grants from wealthy nations

Economic Integration

A process of eliminating restrictions on international trade, payments, and factor mobility.

Free-Trade Area

members agree to remove all restrictive trade barriers among themselves. NAFTA and USMCA

Customs Union

An agreement for members to remove all restrictive trade barriers and to have the same trade policy toward outsiders. Benelux

Common Market

like a customs union with the addition of free movement of factors of production across national borders within the bloc. EU

Economic (Monetary) Union

like a common market with the addition of having common internal economic institutions and requirements (like a common currency). USA and Euro

Fixed Exchange Rate

A government assigns its currency a par value in terms of a key currency. Set the official exchange-rate. Establish an exchange-stabilization fund to defend the rate

Floating Exchange Rate

Exchange rates are established daily in the foreign exchange market without government restrictions. Ex US

Adjustable Pegged Rates

tries to achieve stable rates while allowing adjustment. Pegs are set against a key currency but adjustments are allowed

Managed Floating Rate

Exchange-rate is based on market factors but also has government intervention to some degree.

Monetary Policy Examples

adjusting interest rates, buying or selling government bonds, and changing reserve requirements for banks.

Fiscal Policy

Government uses tax rates and government spending

GATT and WTO

a treaty to promote international trade by reducing tariffs and other trade barriers. It was replaced by WTO in 1995

Tariffs

taxes imposed by a government on imported goods, benefit domestic producers