Economics Exam II: Chapters 8-10

Vocabulary terms, formulas, and concepts from Chapters 8, 9, and 10 of Economics Exam II covering the price level, inflation, the loanable funds market, and financial securities.

Inflation

An increase in the overall level of prices in an economy.

Hyperinflation

An extremely high rate of inflation.

Deflation

When overall prices fall; the inflation rate is negative.

Disinflation

When the inflation rate decreases, but prices may still rise.

Consumer Price Index (CPI)

A measure of the price level based on a typical consumer's consumption pattern.

Bureau of Labor Statistics (BLS)

The government agency that measures and reports inflation.

Price Index Formula

$$(\text{Basket Price} \div \text{Base-Year Basket Price}) \times 100$$

Inflation Rate Formula

$$[(\text{Current CPI} - \text{Previous CPI}) \div \text{Previous CPI}] \times 100$$

Formula for Comparing Prices Over Time

$$\text{Price Today} = \text{Earlier Price} \times (\text{Today's Price Level} \div \text{Earlier Price Level})$$

Concerns About CPI Accuracy

Three specific issues affecting measurement: substitution bias, changes in quality, and new products.

Substitution Bias

When consumers switch to cheaper products when prices increase.

Cause of Inflation

Increases in the money supply.

Equation of Exchange

$$M \times V = P \times Y$$

$$M$$

Money supply in the equation of exchange.

$$V$$

Velocity of money in the equation of exchange.

$$P$$

Price level in the equation of exchange.

$$Y$$

Real GDP in the equation of exchange.

Growth Rate Equation

$$\%\Delta M + \%\Delta V = \%\Delta P + \%\Delta Y$$

Loanable Funds Market

A market where savers supply funds to borrowers, primarily firms.

Suppliers of Loanable Funds

Savers, primarily households.

Demanders of Loanable Funds

Borrowers, primarily firms.

Interest Rate

The price of loanable funds, functioning both as the reward for saving and the cost of borrowing.

Nominal Interest Rate

The interest rate before adjusting for inflation.

Real Interest Rate

The interest rate corrected for inflation.

Fisher Equation

$$\text{Real Interest Rate} = \text{Nominal Interest Rate} - \text{Inflation Rate}$$

Nominal Interest Rate Formula (Fisher Equation)

$$\text{Nominal Interest Rate} = \text{Real Interest Rate} + \text{Inflation Rate}$$

Inflation Rate Formula (Fisher Equation)

$$\text{Inflation Rate} = \text{Nominal Interest Rate} - \text{Real Interest Rate}$$

Factors Shifting Loanable Funds Supply

Changes in income and wealth, and time preferences.

Factors Shifting Loanable Funds Demand

Productivity of capital, investor confidence, and government borrowing.

Bond

A formal IOU or contract specifying repayment of borrowed money.

Maturity Date

The date the bond must be repaid.

Face Value (Par Value)

The amount due when the bond reaches maturity.

Default Risk

The risk that a borrower will not repay the bond's face value.

Bond Interest Rate Formula

$$[(\text{Face Value} - \text{Price at Inception}) \div \text{Price at Inception}] \times 100$$

Bond Price and Interest Rate Relationship

A negative relationship where bond prices rise when interest rates fall.

Rating Agencies

Entities that evaluate the default risk of borrowers.

Stock

An ownership share in a firm.

Secondary Market

A market where securities are traded after their first sale.

NYSE

New York Stock Exchange.

NASDAQ

National Association of Securities Dealers Automated Quotations.

Treasury Securities

Generally low risk bonds sold by the U.S. government to pay for national debt.

Mortgage

A loan individuals use to pay for a home.

Securitization

Combining separate loan agreements to create a new security.

Mortgage-Backed Securities

An example of securitization consisting of bundles of mortgages.