Coppock Exam 1

4 properties of trades

1. trade helps both sides
2. trade creates value
3. trade is a positive-sum game
4. trade encourages diverse interactions

rotunda principle #1

trade creates value

ceteris paribus

all else equal

endogenous/exogenous factors

variables inside/outside of the model

absolute advantage

one producer’s ability to make more than another producer w/the same quantity of resources

comparative advantage

one producer’s ability to produce at a lower opportunity cost than a competitor can

Thomas Sowell

wrote “A Conflict of Visions”

unconstrained vision

we have the resources to satisfy everybody

constrained vision

we have limited resources and unlimited desires

opportunity cost

the highest valued forgone alternative

rotunda principle #2

incentives affect behavior

market power

a firm’s ability to influence the price of a good or service by exercising control over its demand, supply, or both

competitive market

there are enough buyers and sellers in the market that each has a negligible impact on market price and output

imperfect market

where either the buyer or seller can influence market price

things that shift demand

1. income (normal/inferior goods)
2. the price of related goods (complements/substitutes)
3. tastes and preferences
4. number of buyers
5. taxes and subsidies
6. price expectations

things that shift supply

1. cost of inputs
2. changes in technology
3. taxes and subsidies
4. number of firms in the industry
5. price expectations

prices are _____

signals

GDP

market value of all final goods and services produced within a country during a specific period

3 uses of GDP data

1. measuring living standards - per cap.
2. measure economic growth - % change real GDP per cap
3. measuring business cycles

recession

short-term economic downturn, at least 2 consecutive quarters of negative GDP growth, typically 6-18 months

business cycle

short-run fluctuation in economic activity

economic expansion/contraction

phase of the business cycle when economic activity is increasing/decreasing

things NOT included in GDP

* financial instruments
* transfer payments/welfare
* intermediate goods

GDP vs GNP

GDP - produced domestically, even if the firm is foreign owned

GNP - output produced by workers and resources owned by the residents of the nation

components of GDP

GDP = C + I + G + NX

types of consumption

durables - consumed over longer periods, their consumption is a sign of economic health

non-durables - consumed over a short period

GDP deflator

a measure of the price level used to calculate real GDP

real GDP = nom GDP/deflator\*100

% change in nom GDP is approximately the % change in real GDP + % change in price level

4 shortcomings of GDP data

1. non-market goods
2. underground economy
3. environment
4. leisure time

good benchmark for real GDP growth

3%

good benchmark for per capita GDP growth

2%

unemployment

when a worker who is not currently employed is searching for a job without success

unemployment rate

the percentage of the labor force that is unemployed

2 types of natural unemployment

1. structural unemployment: caused by changes in the in the industrial makeup of the economy
2. frictional unemployment: caused by delays in matching available jobs and workers

cyclical unemployment

caused by economic downturns

natural rate of unemployment (u\*)

typical unemployment rate that occurs when the economy is growing normally

full employment output (Y\*)

the output of the economy when u = u\*, potential output, potential GDP

labor force

subset of the work-eligible population

2 shortcomings of the unemployment rate

1. marginally attached workers: haven’t looked in 4 wks but want to work and have looked in the past 12 mos.
2. underemployed workers: have part-time jobs but would prefer to work full-time

U3 vs U6 unemployment rate

U6 includes marginally attached and underemployed workers

labor force participation rate

labor force / work-eligible population

inflation

the growth rate of the overall price level in an economy

price level, P

P = general price level = weighted average of prices of individual goods and services

two measures of price level

1. Consumer Price Index (CPI): based on the consumption patterns of a typical consumer
2. GDP Deflator: based on the prices of all final goods and services in GDP

Milton Friedman quote about what causes inflation

“inflation is always and everywhere a monetary phenomenon”

equation of exchange

M V = P Y

M = quantity of money

V = velocity of money (average number of times a unit of money changes hands in a given year)

P = general price level

Y = output

PY = nominal GDP

Equation of exchange in growth rates

%changeM + %changeV = %changeP + %changeY

7 problems caused by inflation

1. shoe leather costs
2. money illusion
3. menu costs
4. future price level uncertainty
5. wealth redistribution
6. price confusion
7. tax distortions

shoe leather costs

time/resources spent on accounting for inflation; walking to the bank

money illusion

misinterpreting nominal changes in prices as real changes in prices

menu costs

cost of physically changing prices; reprinting a menu/renegotiating a contract

future price level uncertainty

it makes long-term contracts risky and discourages long-term investments

wealth redistribution

if you owe money in nominal dollars, the real value that you owe goes down with inflation; this redistributes wealth from lenders to borrowers. This is bad for lenders. Deflation redistributes money from borrowers to lenders; this is catastrophic

price confusion

prices are signals. firms misallocate resources based on these signals

tax distortions

the capital gains tax taxes assets that appreciate in nominal value, not real value. your asset might be worth more in nominal dollars due to inflation but not real dollars, so you are taxed on “money you made” that you didn’t really make

capital goods (K)

goods used to produced other goods and services

investment

spending on capital goods

Jackson’s quote

Every dollar borrowed needs a dollar saved

axes of loanable funds supply and demand graph

y - interest rate R

x - savings (quantity of loanable funds)

factors that affect supply of loanable funds

1. interest rate (price)
2. income and wealth
3. time preferences
4. consumption smoothing

factors that affect demand for loanable funds

1. interest rate (price)
2. capital productivity
3. investor (firm) confidence

indirect vs direct finance

* indirect involves a middleman (commercial banks) between savers and borrowers
* direct, when borrowers go directly to savers: stocks and bonds, other securities

interest rate on a bond

growth rate between Pm (face value/price at maturity) and P0 (purchase price). P0 is fixed, interest rate is determined by Pm

default risk

will the borrower be able to pay back the loan? the higher the default risk, the lower the dollar price and the higher the interest rate

nominal interest rate (R)

Rate of return in dollars; not adjusted for inflation

real interest rate (r)

rate of return in real purchasing power, adjusted for inflation

Fisher equation

R - i = r

Stocks

ownership shares of a corporation

secondary markets

where securities are traded after their initial sale —> important because “marketable securities” are more valuable

US Treasury Bonds

bonds used to fund national debt, very low default risk, used in monetary policy

home mortgages

loan contracts for homebuyers, like bonds, typically mature in 30 years, difficult to rate

securitization

creation of a financial asset (security) by combining other financial assets